Sovereign Debt 2022: Ukraine Conflict Could Push Developed EMEA’s Commercial Borrowing Higher Than $1.6 Trillion

Key Takeaways

• We project that European developed sovereigns will borrow about $1.6 trillion in gross long-term commercial paper in 2022, down $263 billion from 2021.
• This does not include the increase in borrowing we expect to cover higher spending on energy subsidies, and on defense and refugee assistance in connection with the conflict in Ukraine.
• Our tentative projections are that the additional spending will increase borrowing by €86 billion-€146 billion.
• If this is the case, gross commercial borrowing will dip only modestly this year.

S&P Global Ratings forecasts that the 30 developed sovereigns in EMEA will borrow about $1.6 trillion in gross long-term commercial paper this year, down by $263 billion compared with 2021. We acknowledge upside risks to the total figure, as our projections do not include the higher sovereign borrowing we expect to finance energy subsidies and increased spending on defense and refugee assistance in connection with the conflict in Ukraine. Exactly how much upside depends on whether the additional financing will occur at the national or EU level.

While our estimates are tentative, we believe that roughly half of EU members’ additional funding requirements in 2022 will come from soon-to-be launched EU instruments structured along the lines of the European Commission’s Support To Mitigate Unemployment Risks In An Emergency (SURE) program, approved in May 2020. This would still mean that at the national level, governments will need to raise an additional €101 billion-€173 billion, or 0.7%-1.2% of EU GDP, in
connection with the energy, defense, and refugee spending pressures arising from the Russian-Ukrainian conflict.

Before the conflict, we had projected that sovereign borrowing in the eurozone would decline by €153 billion to €1.3 trillion, as strong growth momentum tends to accelerate fiscal consolidation. However, our tentative projections are that the cost of energy subsidies, defense spending, and refugee assistance will add €86 billion-€146 billion to the total figure, depending on how much of the cost the EU members finance via new EU facilities. This means that gross commercial borrowing will only dip modestly this year once these revisions are taken into consideration.

Despite the pressures, we still project that gross commercial debt issuance will fall considerably for Greece (down 50% versus 2021), Denmark (-47%), Ireland (-47%), Switzerland (-27%), the United Kingdom (-27%), and the Netherlands (-25%) compared to 2021. This reflects quickly narrowing budgetary deficits, and in Greece’s case, low commercial debt redemptions. Although the Russia-Ukraine conflict will likely push up these sovereigns’ gross issuance in 2022, the
overall direction of travel is unlikely to change, in our opinion.

For most large developed European countries, the key effect of the conflict so far is worsening terms of trade via yet another increase in energy and other commodity prices, alongside an intensification of supply side bottlenecks. The potential stagflationary fallout from the conflict has put the European monetary authorities in an awkward position. On one hand, they are worried by what the potentially protracted conflict means for economic growth. On the other, they are not indifferent to indications of rising and cementing inflationary expectations as price pressures broaden beyond just energy.

Short-Term Bills Remain An Important Source Of Financing In These Uncertain Times

We expect short-term bill issuance to remain close to 1.6x pre-pandemic levels, as yet another external shock, the Russian-Ukrainian conflict, is likely to drain cash positions via previously unbudgeted expenditure. At the same time, curve-steepening will incentivize issuance of more short-term securities, particularly given the uncertain timing of the disbursement of the EU’s Next Generation fund and other EU support to member states. In 2021, short-term bill issuance by developed European sovereigns was at 5% of GDP. We see risks that our projections for European
sovereigns’ commercial issuance and debt in table 1b could be considerably higher in 2022. However, most European Treasuries continue to sit on large cash positions, a trend we also observe with local governments, and this gives them considerable flexibility to fund fiscal positions in what looks to be another complicated year for Treasuries.

Borrowing Costs Are Rising From Low Levels

By pushing up inflationary expectations, which were already on an upward path due to pandemic-related demand and supply pressures, the Ukrainian conflict has led to a further increase in euro area borrowing costs. Since we published last year’s borrowing costs in February 2021, Italian yields have increased by 138 basis points (bps), and Spain’s by 108 bps, although both countries are still refinancing debt at below the average cost of total debt. Moreover, euro area governments are still paying nominal rates well below nominal GDP, in most cases over 200 bps lower. The risk is that the increase in yields could continue should inflation become engrained. In this case, further spread-widening would start to reach levels that in the past have led to tightening credit conditions and decelerating growth. However, we are not there yet, and the European Central Bank (ECB) appears inclined to combat a further dispersion of sovereign
financing costs across the euro area.

We expect that upward pressure on rates and uncertainty on inflation will dampen the market appetite for longer-dated issues. The ECB is set to discontinue net asset purchases under the pandemic emergency purchase program (PEPP) at the end of this month, although current holdings under the PEPP will be reinvested until at least the end of 2024. At the same time, the ECB will increase net asset purchases under the asset purchase program to €40 billion in the second quarter of 2022 and to €30 billion in the third quarter of 2022, declining thereafter to €20 billion. As the ECB winds down its net asset purchases, we expect that ECB holdings of sovereign debt will stabilize at around 27% of total debt by year-end, versus 25% at the end of 2021. That still implies net ECB purchases of well over 50% of net euro area sovereign bond issuance this year.

We project that rated developed-market EMEA sovereigns’ commercial debt will total an equivalent of $15.2 trillion by the end of 2022. For a few ex-program countries (those euro area members that required EFSF and ESM assistance during the 2008-2012 euro area sovereign debt crisis), official debt still makes up a significant proportion of total government debt, ranging from about 19% in the case of Ireland, to 76% in the case of Greece. This makes Greece’s servicing costs quite low and its debt maturity structure particularly long.

Since the global financial crisis, the number of ‘AAA’ rated European sovereigns has declined to eight: Denmark, Germany, Liechtenstein, Luxembourg, Netherlands, Norway, Sweden, and Switzerland. We project that the share of these sovereigns’ commercial debt will remain around 18% of the total after an increase last year.

Governments May Frontload Green Bond Issuance

Investors’ generally reduced appetite for very long-dated debt may lead some developed-market governments in EMEA to accelerate their plans for green issuance as their climate-related investments increase. One key constraint we see, however, is that the European Union (AA/Positive/A-1+) will remain active in the European bond markets this year, possibly launching new facilities to assist governments in financing additional costs for energy subsidies, defense
spending, and refugee support.