Europe Risks ‘Explosive’ Path If It Doesn’t Fix Debts, IMF Warns

Europe’s sovereign-debt dynamics are in danger of going badly awry if the region doesn’t get a grip on its public finances, the International Monetary Fund said.

(Bloomberg) — Europe’s sovereign-debt dynamics are in danger of going badly awry if the region doesn’t get a grip on its public finances, the International Monetary Fund said. A piecemeal approach in many nations is running out of road amid increasing challenges including population aging, the energy transition and rearmament, economists including Luc Eyraud, Mahika Gandhi and Andrew Hodge wrote in a paper published on Monday. “If long-term spending pressures are left unaddressed, debt dynamics could be placed on an explosive path in many European countries,” the IMF analysts said.

“Tinkering at the margin is likely to be insufficient given the scale of the necessary adjustment while potentially causing reform fatigue.” The analysis adds to a list of recent warnings on the fiscal vulnerability of sovereigns a decade after a debt crisis nearly splintered the euro zone. Among nations drawing particular scrutiny at present are the UK, France and Belgium, each nursing borrowings at or above the total size of their economies.

Politicians must move “toward a more deliberate, forward-looking strategy — one that combines reforms, fiscal consolidation, and, where necessary, deeper choices about the scope and financing of public services,” they said. “With the cost of delay rising, the benefits of a strategic approach are increasingly clear.” The IMF researchers estimate that countries will see spending climb by an average of nearly 5% of total output by 2040, at a time when economic growth is modest and appetite for higher taxation or large-scale spending cuts remains low.

That will put public debt on an unsustainable path, reaching an average of 130% of gross domestic product, they added. That’s roughly double from today. A “moderate” reform package would close roughly a third of the gap, said the economists, who also include Giacomo Magistretti, Ian Stuart, Mengxue Wang and Jiae Yoo.

Pension overhauls and growth-enhancing measures would deliver the largest positive effects. Fiscal adjustments will still be needed in most countries, they added. “Both are typically required, and both involve politically difficult choices,” the economists wrote.

“The greater the progress on reforms, the less onerous the task of fiscal consolidation is likely to be, but relying on reforms alone would leave fiscal sustainability risks unaddressed.” Some highly indebted countries may have to go one step further still and consider more radical measures that reassess the scope of public services. “Rethinking the role of government does not necessarily imply a retreat of the state or a dismantling of the European social model,” said the IMF economists.

“Rather, it involves a pragmatic reassessment of which services are best financed publicly, which may be more efficiently or equitably financed through greater private participation, and how responsibilities can be reallocated.” The paper cites relatively large governments, comprehensive welfare programs, universal healthcare and free education as features that have supported growth, social cohesion and stability since World War II, but which may now come under pressure. Deeper reforms have increasingly featured in policy discussions between the IMF and governments, it said.

Public wage bills have been a topic in talks with Austria and Croatia, the