'From Germany to Italy, Nato rearmament will weigh on EU countries' credit profiles'

Scope ratings emphasise that Germany is among the few EU Member States able to absorb the defence spending shock from a fiscal point of view, together with sovereign countries that already meet or are close to the correct target (Greece, Poland and the Baltic States) and/or countries with fiscal space such as Portugal and AAA-rated Member States. The German government intends to increase total federal defence spending to 2.4 per cent of GDP in 2025, gradually rising to 3.5 per cent by 2029. In order to support the higher long-term defence spending target, budgetary adjustments will be necessary to stabilise the public debt trajectory. In the case of Germany, the rating agency expects the debt-to-GDP ratio to rise from 63% in 2024 to just over 70% in 2030.

In general, the message coming out of the report is that the weakening of budget parameters affects credit profiles, even though EU budget rules have been eased. Several countries, the paper points out, are already struggling to reduce their budget deficits below 3 per cent of GDP in line with EU fiscal rules. However, more flexible rules reduce the likelihood of more countries facing Excessive Deficit Procedures (EDPs) due to increased defence spending. However, the additional budgetary burden would push away the goal of fiscal consolidation for several countries already subject to an excessive deficit procedure, including France, Belgium and Italy.

Scope Ratings clarifies that its forecasts on debt developments are based on different rates of increase in defence spending. The rating agency expects Central and Eastern European governments to accelerate their efforts early, while Southern European countries (such as Portugal and Italy) and/or those facing significant fiscal constraints (such as Belgium and France) are likely to take a more gradual approach. Spain's decision not to join the recent NATO commitment highlights a divergence in threat perception.

Given the limited financial availability of several EU Member States, the direction of security and defence financing could also shift to the EU itself. In the report, the rating agency notes that centralising the financing of security and defence in the EU could ensure more sustainable and coordinated financing between the Member States while creating economies of scale in defence and security procurement. Such a move would be a significant political step towards deeper European integration.

To address this issue, Scope Ratings recalls, the EU (AAA/Stabile) has adopted a regulation establishing the Security Action for Europe (SAFE) initiative, which will provide an additional EUR 150 billion credit line to Member States. Financed through debt issued by the EU Safe will offer loans to Member States with potential advantages in terms of lower financing costs and longer maturities, with loans of up to 45 years and a 10-year grace period for repayment of principal. The implementation of this programme is expected to increase the EU's bond issuance (EUR 662 billion as of June 2025) and require a larger share of the EU budget to be allocated to interest repayments, especially as of the next multiannual financial framework 2028-35.

Other EU initiatives, the paper goes on to say, include the European Defence Industry Programme (EDIF), which could provide EUR 1.5 billion in grants by the end of 2027 and would focus on improving cross-border cooperation in defence procurement, strengthening defence industry supply chains, and increasing manufacturing capabilities. The proposals also include the creation of a dedicated European Armament Bank, modelled on institutions such as the European Bank for Reconstruction and Development (EBRD). This bank would be financed by a coalition of willing states - potentially both EU and non-EU NATO members - who would contribute initial capital, allowing the bank to leverage its capital by issuing bonds. The bank could offer loans directly to governments for defence procurement and to defence companies to expand industrial capacity. Another proposal is the creation of a broader defence, security and resilience (DSR) bank to support joint procurement, increased production and strategic stockpiling among like-minded allies, including transatlantic and Indo-Pacific partners.