Research reveals that fear of financial markets impedes EU fiscal reform

  • New research by pan-European NGO Finance Watch debunks the fear-driven argument that financial markets will react negatively to more public debt.
  • The report explores why financial markets respond to sovereign credit ratings, an indicator often linked with debt levels in the public debate on fiscal policy. It examines the methodologies of leading credit rating agencies and how these impact investor behaviour and countries’ borrowing costs.
  • It finds that an EU country’s credit rating is not correlated with its debt stock. While credit rating agencies account for debt-to-GDP, what matters significantly more are a country’s economic strength and institutional resilience, and its debt affordability.
  • As the EU finalises a new fiscal framework, Finance Watch calls on policymakers to prioritise market-relevant indicators to identify debt risk, liberate much-needed public investment from arbitrary limits, and incentivise future-oriented investment.

The 2010-12 Eurozone crisis deeply impacted European citizens and shaped the fiscal policy stances of each member state. Although many of the flaws in the euro area architecture that contributed to the crisis have since been fixed, fear of high levels of public debt prevails to an excessive degree. With the European economic governance framework now under review in Brussels, fear is getting in the way of much-needed progress on the fiscal rules, with a German-led coalition pushing back on new, rational ideas for measuring the sustainability of public debt and more future-oriented public investment.

In a report out today, Finance Watch, the pan-European NGO advocating to make finance serve society, outlines why many of these fears are excessive, highlights the need to align European fiscal rules with the financial market reality, and provides reform proposals for policymakers.

The core argument of the report is that financial markets care less about debt stock than about strength and resilience. Sovereign credit ratings, notably those issued by S&P, Moody’s and Fitch Ratings, influence investor decisions. A credit rating downgrade raises the borrowing cost, while an upgrade lowers the borrowing cost. This report shows that contrary to the pervasive fear-driven argument, a country’s ratings mostly correlate to its economy and institutions’ strength, resilience, and debt affordability, not necessarily the size of its public debt.

Take France, a country with a high sovereign credit rating. Fitch Ratings recently downgraded France a notch from AA to AA- citing political deadlock and social movements. However, S&P maintains France’s rating, citing future-oriented public investment, reforms, and debt affordability. Debt-to-GDP was included in their analyses, but it was not the driving force behind the decisions made by these rating agencies.

This argument is further supported by looking at the methodology used by leading credit rating agencies. In the methodology used by Fitch Ratings, which is the most transparent of those assessed in this report, the indicator for debt-to-GDP has a weight of just over 8 percent, while governance is weighted at around 20 percent and GDP per capita at around 13 percent.

Finance Watch calls on policymakers to support the European Commission’s proposal to build the fiscal rules on granular and dynamic debt sustainability analyses (DSA) that look more holistically at what’s happening in EU countries beyond debt-to-GDP ratios and to stop relying on arbitrary debt reduction targets. Given that DSA design decisions are not neutral, Finance Watch calls for a working group to be set up to improve the methodology proposed by the Commission. It argues that the final methodology must better include financial market-relevant indicators, such as debt affordability, debt flows, debt structure, and fiscal risks linked to possible banking bailouts and climate change.

Ludovic Suttor-Sorel, Senior Research & Advocacy Officer at Finance Watch, said:

“Markets don’t obsess over debt-to-GDP, neither should EU policymakers. Arbitrary debt and deficit limits have constrained public spending in the past, overlooking investment needs. Given the challenges we’re facing, Europe can’t afford to continue along this path. It’s time for a new approach that differentiates between productive and unproductive debt, incentivises future-oriented investments, and accounts for country-specific economic conditions and investment needs.”

In “The Debts We Need: Reinforcing Debt Sustainability with Future-Oriented Fiscal Rules”, Finance Watch emphasises that debt for future-oriented investments is key to tackling European economic, social, environmental and geopolitical challenges and would weigh less on future generations’ shoulders than failing to address them.

Finance Watch calls on EU policymakers to allow member states to submit a list of future-oriented investments to be excluded from deficit and expenditure limits as part of their national medium-term fiscal-structural plans, to incentivise EU countries to invest in projects that will benefit generations to come. To avoid bad debt for harmful projects, which is an unfair burden on future generations, it also argues that quality assessment of national plans needs to be strengthened within the new EU fiscal framework.

Future-oriented changes to the EU fiscal rules would be welcomed by investors. Financial markets have an appetite for safe assets, and sovereign debts are in high demand. While less lucrative than stocks or bonds over the last 30 years, they offer the security and liquidity that markets seek. Investor demand for Euro area sovereign debt is twice its supply by member states and the aforementioned reforms can contribute to the expansion of EU sovereign debts while also making this debt safer. Such an approach would improve the ratings of lower-rated sovereigns of significant sizes, such as Spain, Portugal and Italy.

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To arrange an interview with Ludovic Suttor-Sorel, Senior Research & Advocacy Officer at Finance Watch, please contact Alison Burns at or call on +32 (0)471577233

About Finance Watch

Finance Watch is an independently funded public interest association dedicated to making finance work for the good of society. Its mission is to strengthen the voice of society in the reform of financial regulation by conducting advocacy and presenting public interest arguments to lawmakers and the public. Finance Watch’s members include consumer groups, housing associations, trade unions, NGOs, financial experts, academics and other civil society groups that collectively represent a large number of European citizens. Finance Watch’s founding principles state that finance is essential for society in bringing capital to productive use in a transparent and sustainable manner, but that the legitimate pursuit of private interests by the financial industry should not be conducted to the detriment of society.


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