Eurozone governments plan to go deeper into the red than ever before this year, racking up budget deficits of close to €1tn as they splash out on emergency measures to counter the coronavirus crisis.
Draft budget plans published by member states on the European Commission website indicate the 19-country bloc will slide to an aggregate fiscal deficit of €976bn, equal to 8.9 per cent of gross domestic product this year, according to Financial Times calculations.
That means this year’s budget deficits would be almost 10 times higher than both last year’s levels and the commission’s forecasts for this year. Governments estimated their deficits would stay high even when their economies rebound in 2021, when they expect an aggregate shortfall of just under €700bn, or 6 per cent of GDP.
The previous peak in eurozone deficits came in early 2010, according to the European Central Bank, when budget shortfalls rose to 6.6 per cent of GDP. That led to levels of public indebtedness which unsettled investors and sowed the seeds of the subsequent eurozone sovereign debt crisis.
However, there have so far been few signs of alarm from investors or policymakers about the surge in government spending and debt levels. Borrowing costs of peripheral eurozone countries, such as Italy and Greece, fell to record lows last week, driven down by the ECB’s massive bond-buying programme.
“It is clear that both fiscal support and monetary policy support have to remain in place for as long as necessary and ‘cliff effects’ must be avoided,” Christine Lagarde, president of the ECB, said on Sunday. “Otherwise, we risk hysteresis in the labour market, an unnecessary loss of viable businesses and greater inequality.”
The more relaxed attitude towards fiscal extravagance was summed up at last week’s annual meetings of the IMF and World Bank, where senior officials have shifted from calling for austerity to urging countries to throw caution to the wind by borrowing heavily to tackle the fallout from the pandemic.
“First you worry about fighting the war, then you figure out how to pay for it,” said Carmen Reinhart, chief economist at the World Bank.
Marco Valli, chief European economist at UniCredit, said: “Governments have no choice but to keep spending all that’s needed to support their economies and reduce . . . long-term damage.”
The IMF last week predicted euro area government debt, having surged by more than 15 percentage points from last year’s pre-Covid level, would top 100 per cent of GDP this year and hover at a similar level in 2021. Globally, the IMF estimates governments have increased spending or cut taxes by $11.7tn so far this year, equal to 12 per cent of GDP.
The consequent strains on public finances prompted EU leaders in July to sign up to an unprecedented €750bn joint borrowing programme, conducted by the commission, to help the hardest-hit member states pay for the economic damage being done by the pandemic.
Negotiators from the German EU presidency and the European parliament have in recent weeks been attempting to thrash out a deal on the expanded EU budget. But talks have stalled, sparking concerns about a delay to the rollout of the recovery fund next year.
With coronavirus cases surging again across Europe, prompting a new wave of government restrictions that have raised the threat of a double-dip recession, there is no appetite among EU ministers to enact a fiscal clampdown or seek to reverse the debt surge. But ministers will at some point have to begin debating how to handle the EU’s currently suspended fiscal rules.
Early in the crisis, the commission took the unusual step of suspending the stability and growth pact, rules designed to ensure EU countries pursue sound public finances, as it sought to put in place maximum support for economic activity. Valdis Dombrovskis, the commission executive vice-president overseeing the economy, over the summer told the FT the restrictions would not be reimposed until 2022 at the earliest.
The crisis, which plunged the eurozone into a record postwar recession this year, has underlined the deep divide in the public finances of euro area members. By 2025, Germany’s gross debt as a share of GDP will be no more than half the levels in France, Italy and Spain, according to IMF forecasts.