Managing public debt in the CEE-11: challenges, opportunities shift as borrowing costs rise
By Jakob Suwalski, Director, and Levon Kameryan, Associate Director, Sovereign Ratings
Borrowing costs have risen across the 11 CEE countries. Yields on bonds issued by non-euro area CEE-11 countries have doubled since the end of 2021 (Figure 1) as local central banks began raising rates before the ECB and the Federal Reserve to head off currency devaluation that exacerbated inflationary pressure.
The rise in borrowing costs has been more significant for countries with idiosyncratic pressure points, such as Hungary (downgraded to BBB/Stable from BBB+/Negative on 24 Feb), due to the interruption in its receipt of EU funds.
Managing public debt in adverse economic conditions in the context of Russia’s war in Ukraine poses challenges for CEE governments. Issuing too much debt in local currency raises domestic yields, risks crowding out the private sector in the short term. But relying too much on foreign debt exposes public finances to currency risk from a deterioration in external balances given elevated and volatile energy and commodity prices.
Figure 1: Government benchmarks, 10-year, yield, %
Source: Macrobond, national central banks and debt management offices, Scope Ratings.
Interest payments will rise despite the relatively long maturities of CEE-11 sovereign debt portfolios. Slovenia (A/Stable) presents the region’s longest weighted average maturity of debt, at 10 years, while Poland (A+/Negative) has among the lowest at 4.9 years.
The public debt profiles of most CEE-11 sovereigns are less exposed to foreign-currency risk because of better developed domestic capital markets and a long phase of low yields in advanced economies, which encouraged foreign investors to purchase the higher-yielding local-currency debt, driving local yields down. Around a quarter of debt in Hungary and Poland was denominated in foreign currency at end-2022, down from a half and a third respectively in 2011.
Limited fiscal consolidation looks likely in CEE-11 region near term
Local and foreign currency borrowing costs will likely remain elevated in 2023, as central banks maintain tight monetary policy to counter high inflation. Further ECB tightening will keep the borrowing rates of euro area CEE sovereigns such as Slovakia (A+/Negative), Slovenia, Croatia (BBB+/Stable) and the Baltic states under pressure though rates will remain materially below funding rates of non-euro area CEE peers, benefiting from the euro’s global reserve currency status.
Despite challenging financing conditions, CEE-11 governments will likely undertake limited fiscal adjustments in 2023. Budgetary support for businesses and households will continue, pressure is growing to increase spending on and investment in defence and energy infrastructure, even as growth slows. The weighted-average budget deficits of the CEE-11 are projected at 4.3% of GDP in 2023, little change from 4.4% last year.
To tackle high energy prices, governments have earmarked funding ranging from estimated more than 9% of GDP for Slovakia to 2%-4% of GDP in the Czech Republic (AA/Negative), Romania, Poland and Hungary. Poland plans to raise defence spending to 4% of GDP in 2023 from an estimated 2.4% of GDP in 2022.
The sovereign ratings of most CEE-11 countries benefit from moderate outstanding government debt stocks (Figure 2), providing the fiscal space for needed investment. However, general government debt ratios in most cases are expected to stay flat or continue rising in 2023.
Figure 2: General government debt, % of GDP
Source: IMF World Economic Outlook, Scope Ratings forecasts.
Resuming fiscal consolidation in the medium term will be crucial to containing further rises in debt ratios and funding costs. This is especially relevant for countries with other stress factors or sources of uncertainty such as forthcoming elections over 2023-24 (Slovakia, Poland, Bulgaria (BBB+/Stable), Romania) or ensuring a steady inflow of EU funds.
The efficient use of EU funding via national Recovery and Resilience plans (Figure 3) is crucial as it represents off-market financing on favourable terms, which could help finance wider deficits with lesser recourse to foreign-currency borrowing.
Figure 3: CEE-11 national Recovery and Resilience plan implementation progress
Source: European Parliamentary Research Service, Scope Ratings. Data as of 13 March 2023.
Furthermore, EU rule-of-law conditionality holds important implications for government finance outlooks, as it has put the EU in a stronger position to influence member states. Unresolved disputes around the rule of law cloud the economic and fiscal outlooks of Hungary and Poland and serve as a warning for other CEE countries with comparatively higher institutional risk, such as Romania and Bulgaria, of the consequences of backsliding on governance and the rule of law.
This is an updated version of an article that appeared in Poland’s Credit Manager Magazine earlier in March 2023.