Cyprus among EU states best placed for energy shock response

Cyprus is among the European Union countries with the greatest fiscal space to respond to a new energy crisis linked to the war in Iran, according to a new report published by international credit rating agency Fitch Ratings.

In its report titled “European sovereigns’ capacity to absorb another energy shock varies”, the agency said the fiscal ability of western European countries to respond to a new energy crisis triggered by the conflict in Iran differs significantly across the region.

Fitch stated that Belgium, France and the United Kingdom currently have the least fiscal flexibility to introduce additional support measures.

“Many western European sovereigns were already in a vulnerable fiscal position with the war in Iran adding to those pressures through higher energy costs, rising inflation, weaker growth and tighter financing conditions,” the agency said.

“Within the EU, those that have maintained a strong record of fiscal prudence in recent crises – Cyprus, Greece, Ireland, the Netherlands, Portugal, and most Scandinavian sovereigns – have, in theory, the most fiscal space to respond, although with some moderation to prevent a sharp deterioration in debt and deficits,” it added.

The report explained that these countries are considered better positioned to introduce support measures without causing a severe worsening in public debt levels or budget deficits.

Fitch also said that countries which have recorded deficits close to 3 per cent in recent years, including Germany and Spain, still retain room to increase spending in support of households and businesses without materially affecting the trajectory of their debt ratios.

The agency highlighted Spain as being at the forefront of such efforts, noting that Madrid has already announced support measures amounting to 0.3 per cent of GDP.

Regarding Germany, Fitch said additional spending on defence and investment is expected to continue, while further fiscal measures aimed at offsetting the effects of the Iran conflict would place additional pressure on the deficit.

However, the agency said these pressures are likely to be balanced by savings elsewhere, as such expenditures would probably fall within EU fiscal rules and Germany’s domestic debt brake framework.

“We believe that the challenges for Germany relate more to growth and how the latest energy shock will affect the economy,” Fitch stated.

The agency also examined the position of Italy, saying the country’s deficits have narrowed and are approaching 3 per cent of GDP.

Nevertheless, Fitch warned that Italy’s high debt burden and financing costs are likely to constrain its ability to provide large-scale economic support compared with Germany or Spain.

The report added that the Italian government’s strong commitment to fiscal discipline also reinforces this assessment.

“As in Germany, the main challenge arising from the war will be the negative effects on the Italian economy, particularly given the industry’s dependence on natural gas and the higher expected impact on inflation,” Fitch said.

The agency added that targeted support measures accompanied by offsetting mechanisms are considered the most likely outcome for Italy.

Fitch further warned that Belgium, France and the United Kingdom face elevated deficits and debt levels exceeding 100 per cent of GDP.

“These countries have the least space to introduce additional measures and rising financial pressures could act as an important limiting factor, particularly in the UK,” the agency said.

“We therefore expect modest support programmes with offsetting measures,” Fitch concluded.