Just months before his presidency of the European Central Bank ends, Mario Draghi opened the door to further economic stimulus, pushing the cost of borrowing to all-time lows for some Eurozone governments. His monetary move may thus allow fiscal flexibility for cash-strapped countries already struggling to meet EU fiscal rules.
The prospect of a new quantitative-easing programme and lower interest rates has cut yields on government bonds. That could save Eurozone countries EUR120 billion over 10 years, or 1 per cent of GDP – with high-debt nations such as Italy gaining most.
French and German 10-year bond yields are a full percentage point lower than a year ago; Italian, Portuguese and Spanish yields are down 1.5 points. In August, the whole German yield curve was negative for the first time ever.
Eurozone states have already benefited from falling borrowing costs. Rates have tumbled from 3 per cent of GDP at the peak of the euro crisis in 2012, to 1.8 per cent now, accounting for 40 per cent of all the budget-deficit reduction since then. Last year’s Eurozone deficit was the lowest since 2000, just 0.5 per cent of GDP.
The latest sharp fall in yields could mean even bigger savings. A 1 percentage point reduction across the yield curve would lower Italy’s borrowing costs by 0.1 per cent of GDP in the first year, then 0.3 per cent, cumulating to 1 per cent after seven years and 1.2 per cent after ten. At current rates, Italy’s borrowing costs could fall from 3.7 per cent of GDP last year to around 2.3 per cent by 2029.
Sharing in a EUR120 billion bonus may help finance France’s EUR10 billion package to meet ‘gilet-jaunes’ demands without having to find savings elsewhere. It could also fund Spain’s EUR5 billion of expansionary measures while still allowing its debt-to-GDP ratio to fall. And for Italy, facing difficult negotiations with Brussels on its 2020 budget, the interest saving reduces its need to seek offsetting measures if it scraps next January’s EUR23 billion VAT hike.
Low yields usually reflect poor long-term growth prospects, which is bad for debt dynamics. However, the current fall in borrowing costs largely outweighs this and could help debt sustainability, particularly in high-debt countries like Italy, whose debt-to-GDP started to increase again last year, reaching a record 132 per cent of GDP.
Most EU countries face a long-term challenge to their public finances, including spending an average 1.3 per cent of GDP more on pensions over the next two decades. The lower borrowing costs could pretty much offset this.
But while ECB policies should keep yields in core countries low, spreads for riskier countries could still widen. Fiscal discipline thus remains important.
And countries cannot have their cake and eat it. Either they spend the money, or they save it. So if a country uses the additional fiscal space created by lower borrowing costs to support growth, the improvement in debt dynamics will be smaller.
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