Euro-Zone Nations’ Public Finances Are Major Risk, ECB Warns

(Bloomberg) -- Euro-area members must start reducing debt immediately in the face of enormous long-term fiscal risks from ageing populations, defence spending and climate change, the European Central Bank cautioned.

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“These developments will be challenging enough in isolation, and countries will face all of them simultaneously,” it said Wednesday in an article. “Consequently, action needs to be taken today – especially in high-debt countries” grappling with elevated interest rates.

According to the ECB, budgetary efforts required in response to these specific challenges could amount to at least 5% of gross domestic product. “The necessary fiscal adjustment is large by historical standards, but not without precedent,” it said.

The warning comes at a time of heightened concern about the sustainability of public finances in the 20-nation bloc — not least in France, where the shock announcement of snap elections has raised doubts about fiscal consolidation, triggering market turmoil.

On Wednesday, the European Commission reprimanded France, Italy and several other European Union nations for running budget shortfalls above the bloc’s 3% limit.

“Fiscal-sustainability challenges are low in all EU member-states in the short term, while being elevated in the medium and long term in several countries, due to projected high and/or increasing debt ratios in some member-states,” the commission said.

The ECB said that in addition to existing budgetary issues, which are often reflected in high debt ratios, further challenges loom that “will result in significant fiscal burdens in the decades ahead.” Among those, it said, is digitalization.

Governments would have to “immediately and permanently” increase primary balances by 2% of GDP on average to achieve a government debt-to-GDP ratio of 60% by 2070 from today’s debt levels, the ECB said.

On top of that, ageing, defense spending and climate change could widen the average deficit by about a further 3% of GDP, it said. Digitalization is excluded from the calculation because of “the particular uncertainty” that surrounds its implications.

While all countries must act, the report finds “considerable cross-country heterogeneity in the required fiscal efforts” — with estimates of gaps ranging from 0.5% to almost 10% of GDP.

“Economic policies should seek to gradually reduce high levels of public debt and prepare for the future, which will also help to ensure a sound environment for the conduct of the euro area’s single monetary policy,” it said.

(Updates with European Commission starting in fifth paragraph.)

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