December 16, 2020

How threatening is Covid-19 for EA public finances?

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In Short

The 2008 economic collapse and the ensuing euro fiscal crisis triggered a surge in public debt around the world. However, this is set to be dwarfed by the fallout of the cur-rent crisis, as governments have been forced to an unprecedented fiscal stimulus to cushion the economic impact of the Covid-19 pandemic.
How threatening is Covid-19 for EA public finances?
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Highlights:

  • After the Great Financial Crisis and the euro crisis, Covid-19 has been an additional blow to public finances. In the euro area the debt-to-GDP-ratio is set to rise from 84% in 2019 to 100% by the end of this year. 
  • Debt sustainability concerns are particularly relevant for the euro area economies given the lack of a unique fiscal entity. Our analysis suggests that leaving aside Greece, debt dynamics are more concerning in Southern Europe than the rest of the monetary union: low debt costs ensure sustainability in high-debt countries but is not a full replacement for fiscal discipline. The EU Recovery Fund is helpful but generally no game changer. 
  • Rating agencies need more clarity on the growth and fiscal outlook before reassessing sovereign risk. Our model to simulate agencies’ decisions flags, for the time being, a limited risk of a downgrade to HY for any of the major EA countries. 
  • Debt sustainability concerns will not stop the fiscal stimulus needed to digest the Covid-19 shock. However, the deterioration of public finances makes the economies more fragile and will have to be tackled in the longer term.

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