In the first of a series of two reports on government debt in advanced economies, we discussed debt sustainability prospects for some of the world’s largest non-Eurozone economies. In this report, we turn to a discussion of the major Eurozone economies and their prospects for debt sustainability. Concerns about sovereign debt among European countries have waxed and waned for nearly six years. The third bailout package that was cobbled together for Greece last summer has put those concerns on the backburner, at least for now. But how sustainable are the sovereign debt dynamics of some Eurozone economies really?
Financial markets have generally turned their attention to other issues since the last iteration of the European sovereign debt crisis, but long-term government debt sustainability remains an issue for some individual countries in the Eurozone. Among the six economies considered in this report, Germany is the only country in which debt sustainability can be achieved under most “realistic” scenarios, in our view. France, Italy, Portugal and Spain could all achieve debt sustainability if governments remain committed to fiscal discipline, borrowing costs remain low and economic growth stays solid. Greece is in a league of its own. Realistically, we believe the only way that Greece will be able to stabilize its debt-to-GDP ratio is if its creditors, which are essentially the IMF and European public institutions, continue to keep the country afloat via interest-free loans.
If governments in France, Italy, Portugal and Spain want to ensure debt sustainability, then they would need to remain committed to fiscal discipline. In some cases, they probably need to tighten the fiscal screws further. However, fiscal consolidation often leads to slower economic growth, at least in the near term, which makes it more difficult to achieve debt sustainability. A way around this dilemma is to enact structural economic reforms to achieve stronger rates of long-run economic growth. Unfortunately, structural reform is often politically difficult to achieve.
At present, all is quiet on the European sovereign debt front. However, concerns about debt sustainability could resurface at some point if economic growth in some European countries stalls and/or governments become more profligate.
Read the complete commentary here: eurozone-government-debt-20160304