The dynamics of Europe’s sovereign debt could deteriorate significantly if the region does not take control of its public finances, the International Monetary Fund (IMF) warned.
A phased approach in many countries is becoming unsustainable amid growing challenges such as aging populations, energy transitions, and rearmament, economists Luc Eyraud, Mahika Gandhi, and Andrew Hodge wrote in a report published on Monday. “If long-term pressure on spending remains unaddressed, the debt dynamics in many European countries could become uncontrollable,” the IMF analysts noted. “Minor adjustments are likely to be insufficient given the scale of the necessary changes and may also lead to reform fatigue.”
This analysis adds to a series of recent warnings about the fiscal vulnerability of sovereign states a decade after the debt crisis that nearly split the eurozone. Currently, particular attention is focused on the United Kingdom, France, and Belgium, each of which has government debt at or above 100% of GDP.
Need for a Strategic Approach
Policymakers should move “towards a more targeted, forward-looking strategy that combines reforms, fiscal consolidation, and, if necessary, deeper choices about the role of the state in financing public services,” the economists said. As the cost of delay increases, the benefits of a strategic approach become increasingly clear.
IMF researchers predict that by 2040, government spending will rise by an average of nearly 5% of GDP, while economic growth remains modest and the willingness to raise taxes or significantly cut spending is low. This will result in government debt reaching an unstable trajectory, averaging 130% of gross domestic product, roughly double what it is today.
A “moderate” package of reforms could close about a third of the gap, the economists noted, which also include Giacomo Maggioretti, Ian Stuart, Mengxue Wang, and Jie Yu. The most significant positive impact will come from pension reforms and measures that promote economic growth. Fiscal adjustments will still be necessary in most countries, they added.
“Typically, both approaches are needed, and both involve politically difficult decisions,” the economists wrote. “The more progress there is in reforms, the less onerous the task of fiscal consolidation is likely to be, but relying solely on reforms would mean leaving fiscal sustainability risks unaddressed.”
Rethinking Public Services
Some countries with high levels of debt may need to take an additional step and reconsider which public services the state should finance. “Rethinking the role of government does not necessarily mean a retreat of the state or the dismantling of the European social model,” the IMF economists said.
“Instead, it involves a pragmatic reassessment of which services are best publicly funded, which could be more efficiently or fairly funded through greater private participation, and how responsibilities can be redistributed.” The report highlights relatively large governments, comprehensive social security programs, universal healthcare, and free education as features that have supported growth, social cohesion, and stability since World War II but may now come under pressure. Deeper reforms are increasingly becoming a topic of economic policy discussions between the IMF and governments, the report states.
Source: Bloomberg
