Colin Ellis: EU funding plans are key for recovery

Governments will have time to put debt dynamics on a more sustainable footing

Colin Ellis

The differential paces of vaccination we see across countries could drive different economic recovery speeds, says Colin Ellis, Chief Credit Officer, EMEA - Moody's Investors Service, in an interview to EUROPOST.

Global debt has surged to new all-time highs on the back of the ongoing Covid-19 pandemic. Will the debt burden weigh down on the economic recovery of the EU? Do you see a potential danger for the macroeconomic stability of Europe?

Global debt has jumped over the past year and it will jump again this year. It is important to break that down into different sectors of the economy, to differentiate between banks and government and non-financial corporates. One can think of our credit ratings as an assessment of whether people will pay back their debts on time and in full. That is what our ratings speak to. The jumping debt has been associated with deterioration in creditworthiness with a number of downgrades last year. But those were really concentrated in the non-financial corporate sector and in particular for lower-rated entities. In terms of our rating actions for European countries, those have been very modest and limited. We didn't take many sovereign rating actions in Europe last year. That is because, while we do see and recognise the higher debt burdens that governments will have as a consequence of the coronavirus pandemic, we also see that affordability remains very strong. We do see risks, but we have not - as of yet - reflected them in wide-spread sovereign ratings downgrades in Europe. We think governments will have time to take actions to put debt dynamics on a more sustainable footing once the pandemic eases.

Do you foresee an end to the so-called cheap money and a potential increase of interest rates to above the current zero levels?

Policy rates set by central banks are obviously very close to or even in some cases below zero, and credit spreads have also tightened quite significantly after widening last year when the pandemic really hit. But more important than either of those is what has happened to global real interest rates over a longer period of time. There are good reasons why the global real interest rate - that benchmark real rate - has fallen over the past thirty or forty years. We don't expect all of the reasons why global real rates have fallen to unwind quickly. Some will probably not unwind at all. So there are good reasons to think that global real rates could remain low for a prolonged period of time. Ultimately, that will also drive what happens with policy rates. Predicting credit spreads is more difficult, they often remain broadly stable for a while and then blow out in a credit downturn, which is exactly what we saw last year. It is possible that spreads may widen a little from where they are now. But the big interest rate story for me is this global trend in real rates, which started before the pandemic, before QE (quantitative easing), before the global financial crisis. Everything has to be set against that context.

We are in the middle of a pandemic and yet everyone is already talking about economic recovery. Do you believe that the approach to green and digital economy can offset the influence of the pandemic and further support the EU's fast economic development?

Historically, I wouldn't characterise the EU as a place of fast economic development. There are certainly countries where growth is obviously faster, but trend growth rates for the EU as a whole are not particularly striking when you compare them with, for example, China or other fast-growing places in East Asia. I think the recovery plan can support activity, but I don't think it's going to directly offset the effect of the pandemic because most funds released under the European plans will probably be disbursed from 2022 onwards. In contrast, if vaccination and treatment programmes continue at the pace seen in faster parts of the world, the pandemic may fade this year. So there may be a bit of a timing disconnect. I think we recognise that the central EU funding plans are a milestone in the EU's development, both for the way they are being financed and being offered to Member States, and clearly they have the potential to drive digital and green innovation among other changes. I think the challenge will be to do use those funds effectively.

In your view, will the Covid-19 pandemic recovery or the Brexit recovery be the bigger challenge for the EU?

In purely macroeconomic terms we did not see Brexit having a big impact on the EU, though some Member States, and Ireland is the obvious one, have been more exposed to Brexit than others. Since 2016 our view has been that Brexit would do more damage to the UK in an economic sense than to the EU, and that remains our view. So the answer to this question is simple - it is going to be the pandemic. I think the differential paces of vaccination we see across countries could drive different economic recovery speeds. At the moment Europe's vaccination programme is not quite matching the pace seen in the US or the UK. It means that - other things being equal - it may take slightly longer for economic activity in sectors such as hospitality and leisure to open up.

The EU has allocated a huge amount of funds targeted at recovery from the pandemic slowdown. The message of the EC to Member States is to start spending. Is there concern that EU countries may overspend and substantially increase debt levels?

If Member States are spending those funds made available from the EU as grants, that wouldn't directly increase their debts. If Bulgaria receives a certain amount of funds, and many of those are grants, those are not funds that have to be paid back. So it is not Bulgaria taking on debt, it is the EU taking on debt. So far at least, we don't see such central funding from the EU posing a risk even to the EU's credit rating. We still have a triple-A rating (Aaa) with a stable outlook on the EU. More generally, I think the risks are probably smaller than in past cycles when governments may have had to issue their own debt directly and manage their own debt burdens. It is a little bit different this time around.

Do you have a forecast about the economic development, credibility and credit ratings in the medium term when it comes to Europe, and Bulgaria in particular?

We are still waiting to see the Bulgarian government's plan on how they will spend the European funds, and there is a possibility it's delayed because of the upcoming elections. Our forecast as of today, not knowing what that plan will be, is for Bulgarian GDP to grow by 3.2% this year and 3.8% in 2022. But, as always, we will update these numbers as soon as we see something change. I think the challenge for the recovery plan, and this is a challenge for all governments everywhere, is over the longer term. It is normally pretty easy to raise growth temporarily by spending money; if you are building bridges or digital infrastructure or green power or maybe if you are literally hiring people to fill in holes in the road, fiscal stimulus in the short term is normally pretty good at raising growth for maybe a year or two. The challenge always is to have a lasting impact on trend productivity growth so that five, ten years after the fiscal stimulus growth prospects are permanently better, and instead of average growth of 2-2.5% a year, you are averaging growth of 3% a year. This EU programme definitely represents an unprecedented opportunity for governments to rely on that central funding vehicle from the EU and to have considerable funds to try and transform their economies. The challenge will be not whether it generates growth in the first or second year. The challenge is five years, ten years after this, will we see trend growth rates in the EU be higher than what they were before the pandemic.

In your view, what should be the emphasis of government policy for a country like Bulgaria? What is the key to have sustainable development over the medium and long-term period?

We do not give policy advice to governments. What I can talk about is how we see Bulgaria's credit rating. And Bulgaria was one of the few countries we actually upgraded last year. Our current rating is Baa1 stable (outlook), which is a good rating, a solid investment-grade rating. The stable outlook means that we see the risks around that rating as broadly balanced over the next 12 to 18 months. Fiscal strength is something we clearly think is very strong for Bulgaria, where government debt levels are low and high levels of fiscal reserves support that. We see the institutional arrangements in terms of the currency board and the euro area accession project as very useful, they provide a strong policy anchor. We do see some challenges too. On the one side, I think we would recognise issues around immigration and the labour market and skill mismatches. This could potentially damage growth, so anything that improves job matching and skills of the workforce would be positive. Other challenges we note are around the role of the public sector. First, with respect to institutional challenges around rule of law and control of corruption, which remains an issue in Bulgaria. Second, there are some large state-owned enterprises (SOE) with weak profitability - if something goes wrong, the government might need to support them. In a global context I don't think Bulgaria is particularly exposed on SOEs, for example, compared to some other sovereigns that we rate in Africa or elsewhere. But there is a notable difference when looking at some of the measures of institutional effectiveness and rule of law in Bulgaria compared with its slightly higher-rated peers, for instance single-A-rated peers in Europe. Bulgaria's economic strength is probably about average in terms of our global sovereign ratings. There is clearly scope to raise that, to raise per-capita income levels. I think this is a strong opportunity for the country given the funds that it will be receiving because it is, on some measures, the highest beneficiary of the EU funds. But again, it will come down to implementation and effectiveness.


Colin Ellis is Moody's Chief Credit Officer in EMEA and a Managing Director in the Credit Strategy team. He is responsible for identifying and analysing the broad macro and credit trends, and leading and coordinating Moody's ratings approach, across franchises in the region. He is also a member of Moody's Macroeconomic Board, which sets the global forecasts that underpin Moody's universe of ratings. Previously he has worked at the Bank of England, Daiwa Capital Markets and the BVCA. He is a Visiting Research Fellow in the economics department at Birmingham University, and has published on topics ranging from investment and pricing to private equity and data uncertainty. He is also a Fellow of the RSA and holds degrees from York University, the London School of Economics and Political Science, and Middlesex University.

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