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On Monday, January 31, 2022, experts from BSI Economics exchanged views on the sustainability of public debt in Eurozone countries. Here is a summary of that discussion.
Debt sustainability: a question of timing:
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In the short term, concerns are relatively low:
- Despite a sharp increase in outstanding debt, interest rates remain very low (even more so in real terms). Therefore, no significant increase in interest expenses is anticipated.
- Eurozone countries still have easy access to liquidity, thanks in particular to the monetary policy of the European Central Bank (ECB). They would therefore be able to repay their loans and take out new ones.
- The stimulus plans have been welcomed by investors. They have not undermined the credibility of the countriesconcerned, as they were deemed necessary to support and revive economic activity as quickly as possible.
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In the medium term, uncertainty surrounds the ECB’s future decisions. If key interest rates rise, what would be the impact?
- A rate hike could be seen as a sign that economic activity is robust enough to justify a withdrawal of accommodative measures. A reduction in public deficits is to be expected, which would boost investor confidence. However, reducing deficits too quickly, as in the early 2010s, could prove counterproductive (and threaten growth), a view that seems to be shared by the authorities in various countries.
- Investors may nevertheless believe that raising interest rates is not the right response to inflation. While this is the traditional response, the situation is exceptional. At this stage, inflation is being driven by forces other than wages, such as energy prices and supply constraints.
- A rate hike would mean higher interest costs. Countries will need to post high real GDP growth and begin rebalancing their public finances to cope with this.
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In the long term, regardless of whether rates rise or not, concerns are focused more on the trajectory of public debt:
- Will debt stability be achieved through GDP growth and/or a reduction in public deficits (i.e., public spending or an increase in compulsory levies)? Do the most indebted countries still have room for maneuver in the event of new shocks (climatic, economic, energy, etc.)?
- Maintaining the debt trajectory must be compatible with stabilizing and even reducing social inequalities. If these inequalities lead to social unrest, this could cause a negative reaction in the markets and make rebalancing difficult in practice.
Debt sustainability, divergences within the eurozone:
- Southern European countries, particularly Italy, have seen their debt levels rise sharply with the health crisis. They will have to make greater efforts to stabilize their public deficits more quickly or even generate a budget surplus (although the Italian case shows that this cannot be an end in itself).
- In France, the « France Relance » plan appears to be effective. However, doubts remain as to its contribution to the ecological transition. Investing in low-carbon energies is a sure and effective way to combat energy tensions and redress a trade deficit, which is also dangerously fueling inflation.
- Northern European countries are more concerned about the situation of their partners than their own. Their solidarity with southern countries is key to maintaining the credibility of the economic and monetary union, which is itself crucial to helping the most indebted countries stabilize their outstanding debt.
