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26.06.2018

Fiscal and debt levels in CEE: Good so far, but the future will prove more challenging

  • Public debt levels and budget deficits have fallen notably throughout the CEE region in recent years
  • CEE budgets have benefitted a great deal from savings in interest costs and the overall economic upswing
  • CEE countries must still focus on reinforcing fiscal buffers for an eventual downturn, as well as on public investments

The governments in the CEE region have made strong strides over the past few years when it comes to lowering their public debt levels. The gross public debt-to-GDP ratio for the CEE region as a whole declined from 53.9% in 2013 to 48.3% in 2017 – well below the Euro Area average of nearly 90%. Debt reduction was helped by both the pickup of nominal GDP growth and fiscal deficit reduction.

Gross public debt

“Several CEE countries – namely, the Czech Republic, Croatia, Serbia, and Slovenia -- actually managed to run fiscal surpluses in 2017 and all countries in the region came in below the 3 percent of GDP deficit limit set by the Maastricht criteria. What’s more, countries across the region have also managed to significantly raise their foreign currency reserves,” Fritz Mostböck (Head of Group Research at Erste Group) points out. “At the same time, the expected increase of costs related to demographic developments, such as ageing populations and rising health care costs, means that the CEE countries will still need to undertake more efforts to ensure that the currently favourable fiscal situation in the region proves to be truly sustainable and to make certain that they will have large enough fiscal buffers in times of a macroeconomic downturn.”

One reason the fiscal sustainability of the region’s economies could be called into question: the narrowing of their fiscal gaps has been strongly supported by the massive reduction in interest costs and by the cyclical economic upswing – global trends on which domestic governments generally have little influence. Additionally, as consumption-oriented spending has been increasing lately across CEE, the region’s governments appear to want to continue keeping their budgets in-check by cutting public investments.

Constribution to deficit reduction

“Public sector investments are essential for the long-term growth potential of the economies in the region, whose GDP is set to grow by 4.1 percent in 2018 – well above the 2.4 percent projected for the Euro Area. Although cutting such investments is a budgetary approach that is comparatively easy to carry out from a political perspective, this approach could lead to an unfavourable mix in government expenditures,” says Zoltan Árokszállási, chief analyst for CEE macro/FI research at Erste Group.

While no CEE country is currently the European Commission’s Excessive Deficit Procedure, both Hungary and Romania have been put under the Commission’s Significant Deviation Procedure due to their strong divergence from the medium-term budgetary objective (MTO) that the Commission has set for them. Apart from Croatia and the Czech Republic, the other EU-member CEE countries are expected to diverge from their MTOs. However, as non-Euro Area countries do not face any formal penalty for such non-compliance, they will most likely continue to ignore these recommendations from the European Commission.

For all of these reasons, the further adjustment of fiscal figures, changes in the composition of public spending, and structural reforms are essential for the countries in the region. These necessary steps are underlined all the more by the likely reduction (and, in the long-run: complete disappearance) of EU fund inflows, which puts pressure on funding sources for a large part of public investments in the region. CEE countries are likely to see much stricter rules on the spending of EU funds in the 2021-2027 Programming Period (e.g., the need to comply with the rule of law requirement). The likely end of the ECB’s QE in the foreseeable future also increases the pressure to carry out reforms as the interest rate environment might become less favourable than what they have enjoyed over the past few years. It is thus essential that CEE countries do more to create adequate fiscal buffers to prepare for a possible downturn and to find funding for public investment.