ECB rate hike will weaken Spain's debt affordability and fiscal space, according to Moody's

Spain will continue to refinance its maturities at rates below the average of its total debt

MADRID, 10 Jun. (EUROPA PRESS) -

The path of normalization of the monetary policy of the European Central Bank (ECB) will reverse the affordability of the debt and will contribute to reducing the fiscal space of the countries of the euro zone and, in particular, in the cases of Spain, Portugal and Italy, according to Moody's agency.

The change in monetary policy expectations as a result of high inflation has caused an increase in financing costs throughout the euro area, but especially in these three countries, thus partially overshadowing the improvement in debt affordability indicators that began after the global financial crisis.

However, despite this change in trend and as long as countries maintain investor confidence and the ECB is not forced to rapidly raise rates, Moody's believes that "it will take time for higher interest rates to be passed on to higher maturities," while healthy economic growth should ensure continued deleveraging.

The risk rating agency highlights that effective debt management strategies in Spain and Portugal since 2012 will reduce any significant transfer to interest payments. Indeed, southern European countries continue to roll over their maturities at rates below the average cost of their debt, although inflation-linked securities in Spain and Italy will cause affordability indicators to deteriorate as early as this year.

In this sense, he recalls that the average maturity of the debt of the governments of southern Europe is between seven and eight years, which ensures the advantageous financing costs that accompanied QE for a long time.

In the cases of Portugal and Spain, the countries successfully extended the maturity of their debt since 2013 by 1.9 and 2.5 years, respectively, while Italy has maintained an average maturity of around seven years, not very different from 2010.

"So far, the three countries continue to issue below the average cost of their debt, which means that they continue to refinance maturities at lower rates," highlights Moody's, which warns, however, that this spread is narrowing and will continue declining for some time due to the change in the monetary policy environment.

"According to official estimates, every 1 percentage point increase in inflation adds €1.8 billion (0.1% of GDP) in interest costs for Italy and €600 million for Spain (0.05% of GDP)," explains the agency.

On the other hand, he warns that the end of the ECB's asset purchases will mean a gradual change in the composition of public debt holders towards a greater weight of the private sector, which is more sensitive to risk.

Thus, while rising spreads may help attract investors, countries will be more exposed to "idiosyncratic risks that may scare off investors."

Likewise, Moody's considers that the increase in financing costs will not materially delay the reduction of the debt, although it will reduce the available fiscal space.

"Relatively strong nominal growth due to large inflows from the EU and rising inflation will offset rising interest costs and support a sustained decline in the debt burden," according to Moody's.

In any case, the agency warns that a faster-than-expected rise in interest rates or weaker-than-expected growth "could derail debt reduction" because southern European countries are likely to continue to run primary deficits. and, in this context, their ability to provide additional support to the economy without increasing debt would be more limited.