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Eurozone Draft Budget Plans Imply Fiscal Expansion Will Halt

Eurozone countries’ draft budgetary plans (DBPs) for 2021 mostly envisage modest fiscal tightening supported by a substantial economic recovery, Fitch Ratings says. The coronavirus’ resurgence presents risks to these projections, while governments have yet to detail their plans for using the EU’s EUR750 billion recovery fund.

In aggregate, the DBPs project eurozone GDP to decline by 7.7% in 2020, then grow by 5.9% in 2021. Fitch’s GDP forecasts for the 19 eurozone sovereigns result in a sharper aggregate contraction (9%) and weaker recovery (5.5%). The DBPs imply a sharp deterioration in the eurozone’s aggregate general government deficit to 8.7% of GDP this year from 0.6%, before it narrows to 5.8% in 2021.

The aggregate cyclically adjusted primary balance implied by the DBPs shows a moderate tightening of 0.2pp of GDP next year, indicating very slow consolidation after significant stimulus in 2020. However, there are marked divergences across countries, and interpreting cyclically adjusted balances can be difficult given uncertainty around output gaps.

The rise in new coronavirus cases heightens risks to growth and fiscal projections. The aggregate headline deficit improvement in 2021 is driven by winding down temporary income-support measures in most countries, but coronavirus-related restrictions could hit economies over the winter, prompting further support.

Fitch’s forecasts already imply an aggregate 9.4% of GDP deficit this year, wider than the DBPs because our weaker real GDP projection results mechanically in lower revenue growth alongside higher spending for several sovereigns, including France and Spain.

Our 2021 projection is in line with that implied by the DBPs, meaning the general government debt trajectory is marginally more favourable under the DBPs. The aggregate public debt stock peaks at 102% of GDP this year and declines by just 1pp next year. Fitch expects slightly higher public debt this year (104%) and a broadly stable ratio in 2021.

Our debt projections assume crystallisation of some public guarantees. For example, we assume around EUR30 billion (1.8% of GDP) will be used from Italy’s EUR475 billion credit guarantee scheme, as take-up has been relatively slow. For Germany, we assume a direct fiscal cost of EUR180 billion (5% of GDP) from the Economic Stabilisation Fund. Adjusting these assumptions if utilisation rates change could have a bearing on our debt forecasts.

Another factor that will become clearer is the use of Next Generation EU (NGEU) grants and loans. The DBPs provide little information on NGEU, which has yet to be approved by the European Parliament. Spain plans to frontload EUR27 billion from its national budget in 2021 to accelerate its plans for further stimulus before NGEU disbursements start in July. Spain’s DBP estimates that NGEU funds will add 2.5pp to annual growth over the next three years. No other DBP specifies a growth impact from NGEU, although Portugal expects to use EUR500 million from grants in 2021 (of its EUR13.1 billion allocation) to increase public investment.

One common feature of the DBPs is the intention to use NGEU grants, while plans to use loans are less clear. The benefit of NGEU loans may be diminished by the fall in eurozone sovereign bond yields. Lower loan use would imply a lower stock of public debt, but could weaken the GDP boost. The DBPs do not clarify if NGEU grants will finance additional government spending or replace spending that is already budgeted for.

This makes it challenging to fully assess the growth and fiscal implications of NGEU, and we do not yet factor these into our forecasts. More detail will emerge over the coming months, initially in recipients’ Recovery and Resilience Plans. Our individual sovereign assessments will also consider whether NGEU-funded investment is structural or cyclical, and interaction with other economic reforms.
Source: Fitch Ratings

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