NATO Summit: Higher Defence Spending to Further Strain EU Countries' Public Finances

In anticipation of the NATO summit, we have reassessed the potential fiscal impacts of higher defence spending. In our view, if NATO member states were to effectively raise the defence spending target to 5% of GDP, for example by 2030, this could substantially add pressure on medium term public finances, despite the possible benefits to economic growth. We expect the greatest fiscal pressure from expanded military budgets to fall on countries with high debt-to-GDP ratios and those with already wide fiscal deficits. However, a comprehensive assessment of the impact of more defence spending on EU countries' public sector accounts is complicated by uncertainty regarding the timing by when countries will reach the new targets and the flexibility they will have to redirect existing public spending toward defence.

-- Increasingly demanding defence spending targets could further challenge public sector accounts, particularly for highly indebted countries.
-- European support might not be enough to prevent a significant worsening in EU countries' public sector accounts.
-- Additional spending might not benefit EU countries' growth due to capacity constraints and a long-term secular decline in defence spending.

"European defence expenditures are projected to rise by EUR 800 billion by 2030 under the assumption that all countries decide to use the escape clause in full. Achieving the target of allocating 5% of GDP to defence spending, while maintaining conservative fiscal deficit trajectories, will likely require European governments to make difficult budget trade-offs," said Mehdi Fadli, Senior Vice President in the Global Sovereign Ratings Group. "We consider that the three largest and most indebted countries in the EU--Italy, Spain, and France--were they to follow through on the new spending commitments without adjustments elsewhere could face significantly higher budget deficits over the medium term."