ING: How likely is a new debt crisis? In the ‘danger zone’ Spain, France, Belgium, Italy and Greece

Her Eleftherias Kourtalis

A decade after the last eurozone crisis, fears of another crisis have intensified again, notes ING, with Spain, France, Belgium, Italy and Greece in the “danger zone”. After the great shock of the pandemic and in the midst of a war on European soil, it is easy to draw parallels with the crisis period of the past. However, just how alarming is the situation in these five countries?

During the period 2009-2012, three factors created doubts in the minds of investors: (1) the very uneven ability of eurozone countries to recover financially from the financial crisis; (2) the disparity in the competitive positions of various countries within a monetary union, and (3) the severe deterioration of public finances in some countries;

The first factor does not appear to be a major problem at this time. The approach taken during the Covid crisis and amid the war in Ukraine, with both fiscal and monetary policy, allowed most euro area economies to quickly recover to their pre-crisis level of activity. “It is probably too early to say that growth will not be a source of divergence between euro area members, but so far, the situation looks more stable than in the post-crisis period,” notes ING.

Also, things are even more positive about the second factor. Indeed, the structural reforms imposed on the weaker countries during the eurozone crisis have paid off and led to a convergence of member states’ competitiveness levels. In terms of unit labor costs, the huge differences that accumulated during the first 10 years of the eurozone have given way to much smaller differences now. Meanwhile, the cohesion of the eurozone (and therefore its sustainability), which was a key factor in the 2009-2012 crisis, is rather more reassuring today.

The third factor is certainly the most problematic, emphasizes ING. Despite the supportive economic environment between 2017 and 2019, economies did not enter the Covid crisis with the same strength in their public finances. Taking into account two key indicators of the health of public finances (fiscal surplus/deficit and debt ratio), four countries – Spain, France, Belgium and Italy – were already “at risk” in 2019. Following the Covid crisis, a general deterioration in fiscal balances and debt ratios were observed for all economies. Greece joined the group of four countries at risk, mainly due to the sharp deterioration of its fiscal balance.

Debt service interest

The interest burden is an important determinant of the budget balance, as ING underlines. Indeed, a significant part of the primary balance of public finances could be canceled or even slip into deficit due to an excessive interest burden on the debt. In this respect, not all countries are in the same position.

Spain is in the most problematic situation. Not only is the primary deficit larger than the eurozone average, but the interest burden (more than 2% of GDP expected in 2022) is also higher than average.

Belgium and France face an interest burden on their debt similar to the EU average (as a percentage of GDP). Therefore, their poor performance in the budget balance is mainly associated with an excessive primary deficit. Only increasing tax revenue or reducing current spending will help correct this.

Greece and Italy are in the opposite situation: their primary balance is better than the European average. From the other side, these countries are penalized with a much higher than average interest burden (as a percentage of GDP) due to higher public debt and a higher interest rate on debt.

Which country from the five above is at risk of a new debt crisis?

At this stage, no economy is in a very difficult situation, ING points out. Economic performance and levels of competitiveness hold the eurozone together rather than acting as a centrifugal force. On the other hand, it cannot be denied that some countries present certain risks in terms of public finances.

It is therefore important to continue the recovery path, ING emphasizes, while particular attention should be paid to improving public finances in the five countries in the risk zone. This will help prevent the kind of drift seen during the last crisis. The evolution of interest rates will also play a role in maintaining European cohesion, certainly in the case of Spain, Italy and Greece. It is important that bond spreads do not endogenously worsen the situation by increasing the interest rate burden of these countries.