Risk of a European Fiscal Funding Crisis Exaggerated, Says Fitch
Fitch Ratings said the surge in European government borrowing underway in 2009 is on a historically large scale but is manageable. However, further sizeable increases in the share of short-term debt (STD) could become a credit concern.
“Fears of a fiscal funding crisis as European government borrowing rises sharply amid more volatile market conditions look exaggerated,” said Brian Coulton, managing director in the sovereign group. “The sheer scale of government issuance in late 2008 under extremely stressed financial market conditions was testimony to their market access. We expect the recession to result in a large increase in private sector savings and sharp falls in investment rates that will help facilitate increased flows of funds to governments. Nevertheless, we see potential concerns arising if governments come to rely too heavily on short-term debt.”
Fitch projects European governments’ total gross borrowing requirements (including maturities of medium- and long-term debt (MLT) and roll-over of STD) to be €1,988bn in 2009, or 17% of GDP. This would represent a 45% increase on 2008. For the five largest borrowers combined, this would be a record as a percentage of GDP, exceeding previous highs in the mid-1990s, when Italian gross borrowing levels were much higher than today. Higher net borrowing is a key factor driving up gross funding needs. Fitch expects fiscal deficits to widen across the board, but to be particularly large in the UK, Ireland and Spain. In addition, significant funds still need to be raised for recently announced financial-sector support measures. Net borrowing will be highest relative to GDP in the UK, Ireland and Switzerland, the latter reflecting the scale of financial-sector support. Higher net borrowing will see government debt ratios rise sharply. Nevertheless, Fitch does not currently forecast public debt levels to rise above thresholds that would threaten existing ratings.
The rise in funding needs will likely contribute to ongoing volatility in European government bond markets. However, Fitch does not anticipate that high-grade European sovereigns will face constraints in accessing market funding on the scale required. Recent government bond auction ‘failures’ reflect challenges in price discovery for issuers in a more volatile and stressed financial environment, but there are few grounds for believing that price adjustments will not ultimately serve their function of equating supply and demand. Furthermore, the private sector will likely shift heavily into financial surplus as saving rates rise and investment falls, releasing funding flows for government borrowers. Nevertheless, market volatility raises the possibility that sovereign borrowers could rely excessively on STD to meet funding needs. Sizeable further increases in the share of STD would increase sovereigns’ exposure to market risk and see refinancing risks ratchet upwards and could become a credit concern.