By Eiko Sievert and Tom Giudice, Sovereign and Public Sector

Outstanding EU (AAA/Stable) debt issuance is set to surge tenfold to almost EUR 1trn by end-2026, up from less than EUR 100bn in 2019 reflecting EU-wide financial support provided in response to recent crises which resulted in the creation of a robust new funding framework.

Yet, additional public funds are needed to narrow the EU’s large investment gap of around EUR 500bn a year. Closing the gap will require both public and private investment, including large-scale public-private partnerships, future common EU debt issuance, and direct private capital mobilisation.

The growing influence of far-right parties in the European Parliament and in national parliaments of member states will pose a challenge to fulfilling the investment task confronting the European Commission over the next five years. Faster progress of the capital markets union (CMU) will therefore be a key priority to mobilise private sector funding.

Rise in far-right political influence will constrain mainstream policy making…

Although far-right parties have increased their presence in the EU parliament following recent elections, they are unlikely to derail mainstream policymaking. Still, with individual heads of state driving the main political priorities and overall policy direction in the European Council, the growing influence of far-right policy views on many national governments could slow progress in some policy areas such as the green transition.

Most member countries that are net contributors to the EU’s medium-term budget, which also tend to be higher-rated sovereigns, have seen a political shift to the right in recent years. This trend may limit European politicians’ willingness to agree on establishing future common debt instruments and investments.

…while political fragmentation and weak public finances may curb domestic public investment

French President Emmanuel Macron’s decision to hold a snap parliamentary election after a surge in support for far-right parties in the European election, highlights the increased political fragmentation which further raises uncertainty over governments’ ability to effectively tackle rising fiscal challenges.

Several member states face high fiscal burdens, with debt-to-GDP ratios by the end of 2024 set to exceed 100% in Greece (155%), Italy (140%), France (112%), Belgium (106%) and Spain (105%), limiting strategically important investments in the EU. Fiscal consolidation thus remains crucial but may result in lower public investment.

Under the revised EU fiscal framework, excessive deficit procedures could be announced for around 11 countries including Italy, France, Belgium and Spain. Implementing subsequent fiscal reform will be critical as non-compliance with medium-term targets could disqualify countries from other crisis support mechanisms such as the ECB’s Transmission Protection Instrument.

Enhancing capital markets union needed to mobilise private investment

Given the fiscal and political constraints for additional EU-wide and domestic public investments, we anticipate accelerated efforts to enhance the CMU. This is needed to narrow the EU’s investment gap, as most financing will need to come from the private sector. Still, to date, the use of capital markets by corporates and households significantly lags that of other large economies, highlighting the challenge ahead.

EU companies continue to rely heavily on bank funding and, over the past three years, have raised just 10.7% of their total new funding needs from capital markets. While there are clear differences between member states, with a higher share in France (17%) than in Germany (9%), the EU overall lags countries that benefit from deeper capital markets such as the UK and the US, where more than a quarter of corporate financing comes from bond or equity issuance.

Households in the EU also have a low portion of their savings invested in capital markets, equivalent to around 90% of GDP, although there are exceptions such as Denmark (187%) and the Netherlands (174%). This is significantly lower than in the UK (182%) where households invest heavily in insurance and pension products, and far behind the US (311%) where households tend to have lower cash holdings and a high share of their financial assets held in listed equity and investment funds.

The EU has shown a more encouraging record in green financing. The strong commitment in recent years to the green transition is reflected in its leading role in ESG bond issuance as a share of total issuance – both at EU and individual member state level. While a stronger emphasis on supporting the EU’s energy independence and other strategic priorities is likely, we expect continued strong green bond issuance in the EU.