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European Sovereign Debt Levels to Surge on Climate, Ageing Costs

Climate change and demographic shifts will be the biggest threats to sovereign debt sustainability in Europe over the medium-to-long term, with wide variations across regions. A new research note by Scope Ratings said emissions reductions would have “profound economic implications” while population ageing will have an “important impact” on countries’ growth and fiscal outlooks. The ratings agency said ageing presented the greatest risk through 2050, raising public debt as a share of GDP by 21 percentage points on average, with the costs of a disorderly transition adding a further five percentage point rise to debt levels. Combined with poor underlying debt dynamics in western and eastern regions, these long-term trends could lead to a “substantial increase” in public indebtedness without an effective policy response. Climate and demographic shifts will pose a relatively contained risk at first; debt trajectories are expected to be broadly similar for the next decade, diverging “materially” thereafter. Southern Europe has relatively strong debt dynamics, said Scope, partly due to past reforms to address long-term pension liabilities, but face the highest climate risks and the lowest credit ratings. The firm also said effective climate action “could conflict with the consolidation objectives under the EU fiscal framework”, with countries unable to an inability to deliver on Paris commitments within proposed new fiscal rules. Noting the risks of “irreversible” physical damages under certain scenarios, Scope added: “Despite the near-term transition cost, mitigating GHG emissions through early and effective climate action could prevent an unsustainable debt increase during the second half of the century and remains the best policy option to avoid irreversible damages.”

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