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No country would be at high risk of fiscal stress in the short-term
The identification of risks to fiscal sustainability over the short term (the upcoming year) relies on the S0 indicator (as in the FSR 2015).
Based on the latest information, S0 results confirm that no EU country (analysed in this report) would be at high risk in the short-term, as was the case in the FSR 2015. Risks of short-term fiscal stress are significantly lower compared with the situation in 2009 (first crisis year).
High risks to fiscal sustainability for 12 countries and medium risks for another 4 over the medium-term
The assessment of medium-term sustainability challenges relies on the joint use of the debt sustainability analysis (DSA, run over a 10-year horizon) and the S1 indicator, as in the FSR 2015. The joint use of the DSA and S1 allows capturing medium-term sustainability challenges in a comprehensive way, by considering fiscal risks related both to population ageing and to other risk factors affecting future debt developments.
As many as 12 EU countries (BE, ES, FR, HR, IT, CY, HU, PL, PT, SI, FI and UK) are found to face potentially high sustainability challenges in the medium term. For the large majority of them (8 out of 12), risks are deemed to be high based on both the DSA and S1. Exceptions to this are only HR, HU, PL and SI, which would be at high risk for the DSA, while at medium risk for S1. In all four cases this is due to a debt ratio at the end of projections, under the baseline no-fiscal policy change scenario, above the 60% Treaty reference value, accompanied by high risks highlighted by one or more of the alternative debt projection scenarios or sensitivity test scenarios, in terms of either significantly higher debt ratio or still increasing debt ratio at the end of projections (see Tables 2 to 4 for more details about the risk classification).
Four EU countries are deemed to be at medium sustainability risk in the medium term (IE, LT, AT and RO). For 2 of these four countries, the medium risk assessment is aligned between the DSA and S1 (IE and AT). Among the other two medium-risk countries in the medium term (LT and RO), medium risks are highlighted by S1, while the countries would be at low risk based on their DSA. In the case of LT, the impact of the projected cost of ageing would largely drive the positive value of S1, while in the case of RO the initial budgetary position (IBP) would be the main contributor to the positive S1.
The remaining 11 EU countries (BG, CZ, DK, DE, EE, LV, LU, MT, NL, SK and SE) are deemed to be at low risk in the medium-term(based on both DSA and S1).
Overall, medium-term fiscal sustainability risks would not have substantially changed compared to the 2015 FSR with approximately the same proportion of countries deemed to be at high / medium / low risk respectively. In terms of composition, the level of risk is deemed to have increased in HU and PL (from medium to high), while in three other countries, it would have decreased (IE and RO, from high to medium, and NL, from medium to low).
Sustainability challenges remain at the aggregate EU and EA level
Under the baseline no-fiscal policy change scenario, the debt ratio for the EU as a whole would gradually decline from a peak of more than 88% of GDP in 2014 to 80% in 2024, and thereafter rise slightly. For the EA, the same projection scenario shows a sharper decline of public debt ratio from more than 94% of GDP in 2014 to around 85% of GDP in 2027. Despite this overall downward trend, the EU (EA) debt ratio would remain in 2027 significantly higher than its 2009 pre-crisis level. Compared to the FSR 2015, the EU (EA) debt ratio at the end of the projection period would be slightly higher due to a slightly loser fiscal stance over the coming two years compared to last year's forecasts.
If the structural primary balance for the EU (EA) gradually reverted to its last 15-year historical average, the projected decrease of the debtto-GDP ratio would halt in 2022 for the EU (in 2023 for the EA), year after which public debt over GDP would start rising again.
Adhering to the existing fiscal rules (full compliance with EDP recommendations and convergence to the MTO according to the Communication on flexibility in the Stability and Growth Pact, SGP) would bring about a significantly higher decrease in gross public debt over GDP relative to the case of unchanged fiscal policy beyond forecasts. Indeed, in this case, public debt would reach 66% of GDP in 2027 for the EU (around 69% of GDP for the EA), a level around 16 pps. of GDP lower than what is projected under the baseline no-fiscalpolicy-change scenario.
Stochastic debt projections (featuring the uncertainty of macroeconomic conditions in the analysis of debt dynamics) show that the EA debt ratio in 2021 is projected to lie between roughly 80% and 91% with an 80% probability. In terms of debt dynamics, in the presence of temporary shocks to primary balance, interest rates and nominal growth, the EA's debt ratio is projected to continue rising in 2017 with a probability of less than 40%, and start decreasing afterwards with a 80% probability. The EA debt ratio in 2021 is expected to be lower than in 2016 with a probability of around 91%.
In terms of medium-term challenges at aggregate level identified by the S1 indicator, the required improvement in the structural primary balance beyond the forecast horizon to achieve a debt-to-GDP ratio of 60% by 2031 amounts to 2.3 and 2.7 pps. of GDP for the EU and the EA respectively over the period 2019–2023. If the level of the S1 indicator at the EU (EA) level could be interpreted as signalling medium (high) medium-term risks, aggregating fiscal sustainability needs (respectively fiscal scope in countries where S1 is negative) to appropriately assess overall EU (EA) fiscal sustainability challenges is not a straightforward exercise. The report provides some alternative measures (see Box 3.2 in chapter 3).
A prolonged period of low interest rates would on the other hand enhance sustainability
There is uncertainty and a vivid debate as to when and to what extent interest rates will return to 'normal' levels. If the current environment of very low interest rates was to last during a longer time period than the one assumed in our baseline scenario (and other main alternative scenarios), then public debt would decline more substantially: for instance, in 2027, the EU public debt ratio would be almost 5 pps. of GDP lower than in the baseline scenario (see Box 2.3 in chapter 2).
Furthermore, with a prolonged period of low interest rates, the required fiscal adjustment, to bring down the debt ratio to 60% of GDP in 2031 (measured by the fiscal sustainability indicator S1), would be reduced by more than ½ pps. of GDP at the EA aggregate level, as the gap to the debt-stabilizing primary balance would diminish, as well as, to a lower extent, the cost of delaying the fiscal adjustment.
However, this current favourable environment alone would not suffice to ensure medium-long run public debt sustainability: indeed, the secular stagnation literature also predicts a long-lasting environment of low growth, which could reduce favourable snow-ball effects; 'low for long' interest rates may also have undesirable effects on the soundness of the financial sector, eventually favouring the build-up of contingent liabilities, whereby the sustainability challenge would transform. Finally, highly indebted sovereigns remain vulnerable to possible rapid changes in financial markets' sentiments.
Gross financing needs have fallen in recent years and are expected to remain broadly stable in coming years
Although the debt to GDP ratio remains the main metric of the debt sustainability framework, the current environment of very low interest rates calls for giving due account in the analysis to another indicator capturing the 'ability' to service debt. Hence, public gross financing needs' estimations and projections are presented in this report. This is an addition compared to the 2015 FSR. The projected dynamics of gross financing needs is particularly important to be able to measure the extent to which governments might need to tap financial markets over the current and the coming years, thus enabling an assessment of rollover risks.
According to Commission services (DG ECFIN) estimations, in most countries, government borrowing requirements have considerably decreased compared to the level reached in 2012 (down from around 22% / 26% of GDP at the EU / EA level to around 16% / 18% of GDP at the EU / EA level in 2016). Important cross-country differencesappear in line with the heterogeneity in terms of public debt level and maturity structure, sovereign financing conditions, as well the government primary balance. For instance, in 10 countries, GFNs are below 10% of GDP in 2016 (sometimes well below this value like in LU, LT, IE, DK and LV), while 7 countries exhibit GFNs greater than 17% of GDP (IT, CY, ES, PT, BE, FR and HU).
Over our 10 year projection horizon, gross financing needs are projected to remain roughly at their current (2016) level, with a slight overall decrease up until 2022, followed by a limited increase thereafter. Several countries are projected to experience decreases of their borrowing requirements over the whole period (e.g. BG, SE, SK, MT and DE), while others should see their GFN increase by 2027 (e.g. LT, ES, HR, FR, FI, RO and PL). These trends are largely driven by the projected dynamics of the primary balance (in line with often increasing costs of ageing) and the projected increase of the interest bill (in line with the assumption of normalization of financial conditions). They would remain however well below the peak reached in 2012 in most countries.
Medium or high risks to fiscal sustainability for 14 countries over the longterm
Long-term fiscal sustainability challenges are identified based on the S2 indicator, under the baseline no-fiscal policy change scenario, as traditionally done in previous issues of the FSR.
S2 results show that only one country (SI) appears to be at high longterm sustainability risk, primarily due to projected cost of ageing developments (with spending on pensions accounting for most of the projected impact on public finances). 13 EU countries (BE, CZ, LT, LU, HU, MT, NL, AT, PL, RO, SK, FI and UK) appear to face medium risk in terms of long-term sustainability challenges. For as many as 9 of these countries (BE, CZ, LT, LU, MT, NL, AT, SK and UK), these challenges are brought about primarily (exclusively for LU, MT and AT) by projected age-related costs. For other 3 countries (HU, PL and RO), on the contrary, long-term challenges are primarily brought about by their initial budgetary position (IBP). For the last country (FI) long-term challenges are brought about by the cost of ageing and the IBP to the same extent. The remaining 13 EU countries (BG, DK, DE, EE, IE, ES, FR, HR, IT, CY, LV, PT and SE) appear to be at low sustainability risk in the long run, conditional on fiscal policy unchanged at the last Commission forecast year, as assumed in the baseline scenario.
If less favourable ageing cost projections were to materialise over the long term (especially due to higher healthcare spending, as assumed under the AWG risk scenario, or due to the structural primary balance returning to its historical value under the historical SPB scenario), significant changes would intervene in terms of long-term fiscal sustainability challenges. Two countries (CZ and MT) would be facinghigh, rather than medium, risks over the long term, while other 10 countries (BG, DK, DE, EE, IE, ES, FR, LV, PT and SE) would face medium, rather than low, risks.
Overall, long-term fiscal sustainability risks would not have changed based on the S2 indicator, with still only one EU country at high risk and 13 countries at medium risk (against 14 in the 2015 FSR). Looking at the classification country by country, the long-term classification has changed for three countries, with an improvement of risk category in two cases (BG and SE, from medium to low), and a deterioration in one other case (HU), driven by the change in the initial budgetary position.
Additional fiscal risks arising from nonperforming loans on banks' balance sheets exist and require close monitoring
Finally, to complement our sustainability analysis, the report explores (like in the FSR 2015) additional potential risks or mitigating factors linked to i) the structure of public debt, in terms of maturity, holders and currency, ii) government contingent liabilities primarily linked to the banking sector, and iii) government assets.
As far as governments' contingent liability risks from the banking sector are concerned, the main vulnerability stems from the share of non-performing loans, which appears to be problematic for almost all EU countries with few exceptions (EE, LU, FI and SE), thus representing a significant source of fiscal risks at the current juncture. Non-performing loans however have been reducing across the board, except in Portugal where the share has increased. A further qualifier of bad assets, the NPL coverage ratio, shows that in most countries NPLs are provisioned for in significant proportions and that only in few cases NPLs are both relatively high as percent of total loans and provisioned for at insufficient levels (DK, LV, LT and UK).
Given the strengthening of the regulatory framework in recent years (e.g. Banking Union), the impact of a systemic banking crisis on public finances would be overall limited. Contingent liabilities, linked to the banking sector, have a potential high impact on public finances only for a very limited subset of countries and only in the short term.