More difficult financial conditions will challenge investment plans and drive spending higher, while central government pandemic-related support is gradually withdrawn. Supportive factors include institutional frameworks that have proved resilient during consecutive crises and robust debt profiles at the regional and local level, shielding sub-sovereign finances from less favourable financing conditions.

“In this context, reform of institutional and fiscal frameworks remains important, though we see uneven progress after successive crises,” says Giacomo Barisone, head of sovereign and public sector ratings.

“Despite significantly matured frameworks in Europe over recent years, governments will have to strike the right balance between centralising and decentralising financial resources post crisis, to enhance both the resilience of sub-sovereign finances to shocks and debt sustainability in the long run,” he says.

Uneven impact of inflationary shock across Europe

Budget structures and flexibility will determine sub-sovereigns’ ability to cope with the inflationary shock in Europe. Some budget items are more cyclical than others and will thus be more vulnerable to slowing economic growth while some are more sensitive to inflation. Given greatly varying budget structures across Europe, the impact of inflation will inevitably be uneven.

“On the sub-sovereign funding front, robust debt profiles will shield many regions, municipalities and cities from higher financing costs, while new issuance volumes are likely to be subdued,” says Barisone.

Finding fiscal room to accommodate for rising interest payments could prove challenging for highly indebted sub-sovereigns with rigid budget structures. Improved debt profiles and moderate recourse to debt in view of available NGEU funds and the re-implementation of fiscal rules will support sub-sovereign debt sustainability.

Sub-sovereigns account for a large share of general government climate-related spending. Multi-level government coordination of climate-action remains challenging despite the pivotal role of regions and cities in driving the transformation towards climate neutrality and the green transition.

For Europe’s less advanced economies, meeting high investment needs under budgetary pressures, often related to Russia’s war in Ukraine will be challenging, in the context of limited financial autonomy at the regional and local level in much of Central and Eastern Europe. Support from international development banks remains crucial in their programmes to enhance infrastructure investments and policy making.

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