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With the emphasis shifting to fiscal rather that monetary policy as the principal mechanism for raising economic growth in the region, Scope’s stress-test of EU government balance sheets – including of the UK’s as a former member state – takes a quantitative look at what the balance-sheet impact would be under an adverse economic and financial scenario.

“We are essentially asking one question: how much risk exists to fiscal positions when we consider the weakening in governments’ gross liability positions in the event of a future crisis?” says Levon Kameryan, analyst at Scope and co-author of the report: Fiscal and debt trajectory risks: a comparative assessment of EU member states.

“Our analysis, which combines quantitative variables for fiscal risk used in Scope’s sovereign methodology alongside a debt-sustainability assessment under a stress case, shows that some countries where finances were hit hardest during the global financial and euro area crises remain comparatively most at risk, at least when viewed compared with regional peers today,” says Kameryan. Italy (BBB+/Stable), Spain (A-/Stable) and Greece (BB/Positive) are the three euro area economies in this category. Outside the euro area, Romania (BBB-/Negative) is also at greater risk. Ireland (A+/Positive) moreover shows significant vulnerabilities under the stress examination.

“All represent nation-states where public finance risk is high and which, under stress, would reveal deeper vulnerabilities,” says Dennis Shen, co-author of today’s report. “The UK falls into this class as well.”

The UK’s budget balance has deteriorated slightly since the 2018-19 tax year (from -1.8% of GDP in 2018-19 to an estimated -1.9% of GDP in 2019-20), with more significant deterioration expected in the 2020-21 fiscal year.

“The UK’s gross debt ratio declined only somewhat over a four-year period to 84.2% of GDP as of Q3 2019, remaining well above Germany’s 61.2% debt ratio for example,” says Shen. “However, one important factor that differentiates the UK from euro area economies like France and Belgium is the former government’s relatively moderate financing needs, reflecting importantly the UK government’s very long average maturity of debt.”

France and Belgium (both rated AA) are among countries that have comparatively high prevailing budget and debt risks, but display comparative resilience in the stress scenario. France’s primary deficit (expected at 1.3% of GDP over the medium run) as well as elevated government debt and gross financing needs of just over 100% of GDP as of Q3 2019 and around 13.5% of GDP over 2020-21 respectively explain fragilities. Belgium also has high debt ratios and gross financing needs, at an estimated 99.1% of GDP in 2019 and 14.6% in 2020 (including the refinancing of short-term debt), despite lower primary budget deficits expected at around 0.4% of GDP in 2020 under a no-policy change scenario.

In central and eastern Europe, Estonia and Czech Republic have the lowest fiscal risks with amongst the lowest debt ratios in the EU at 9.2% and 32.0% of GDP as of Q3 2019. Poland and Hungary show comparative resilience in the case of a future shock, despite medium-term budget deficits seen at near 2% of GDP.

“The least fiscally fragile economies under the stress test results are Luxembourg, Germany, Austria, the Netherlands and Sweden – all rated AAA,” says Kameryan. “They not only show fewer existing fiscal vulnerabilities but are better positioned to deal with a future crisis were one to occur.”