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The recent elections in France and the U.K. were respectively inconclusive and decisive, but there is at least one commonality: challenging public finances—a condition that holds true across the Group of Seven (G-7) and the EU.

What We're Watching

In recent years, a series of global emergencies, at a time of unusually low interest rates, boosted government borrowing. Despite sharp increases in government debt, there has been a lack of urgency among large developed-market sovereigns about how to improve public finances. Six sovereigns (G-7 members France, Italy, and the U.S., along with Belgium, Finland, and New Zealand) that collectively account for 60% of developed economies' output will see their debt-to-GDP ratios rise further in the next few years.

This could be particularly problematic for EU states, where post-pandemic economic growth hasn't matched that in the U.S., and where individual EU member states' government bond markets pale in comparison to the U.S. Treasury market in liquidity and depth. Unlike in the rest of the world, EU member states are committed to abide by specific fiscal rules as a condition for membership in the economic bloc. Under the recently revised fiscal governance framework, the European Commission recommended to the European Council that it initiates a so-called Excessive Deficit Procedure (EDP) for seven EU members: Belgium, France, Hungary, Italy, Malta, Poland, and Slovakia. In most cases, this is because these sovereigns are in breach of the general government deficit threshold of 3% of GDP.

Historically, the consequences of non-compliance with EU fiscal rules for member states have been modest. Nonetheless, non-compliance could be consequential for a country's cost of debt. Under the guidelines governing the European Central Bank's ability to prevent the dislocation of sovereign bond spreads across the euro area—known as the Transmission Protection Instrument (TPI)—the debt of EU members states that are under an EDP are, strictly speaking, ineligible for TPI purchases.

This ineligibility could add significantly to a government's debt-servicing costs, especially if its budgetary position deteriorates further. Of course, monetary policy is discretionary, and it will be up to the ECB to determine when spread widening is warranted based on fiscal fundamentals, and when it is not. But this is a fine line.

What We Think And Why

S&P Global Ratings expects that some of the largest G-7 sovereigns won't deliver budgetary consolidation sufficient to stabilize their debt-to-GDP ratios (which we estimate to be equivalent to at least 2% of GDP for most of these sovereigns). In light of lingering post-pandemic spending pressures, several European governments are finding it difficult to adjust their fiscal balances to less than 3% of GDP. Governments' 2025 budgets, to be submitted to the European Commission this autumn, should indicate how serious authorities are about repairing public finances. In the U.S. (AA+/Stable/A-1+), which registered a general government deficit of more than 9% of GDP in 2023, the electoral outcome will be equally crucial to determine the fiscal stance of the world's biggest economy.

And the new political landscape in France (AA-/Stable/A-1+) is likely to add to difficulties in decision-making. Given the split parliament—in which no party came close to securing an absolute majority—the government may struggle to implement meaningful policy measures. The 2025 budget, due in October, will give some sense of the government's willingness to reduce the country's large budget deficits and comply with the EU's fiscal rules. Ultimately, the government's approach to public finances, and to economic and budgetary reforms, could be key to determining France's creditworthiness going forward.

Similarly, while elections in the U.K. (AA/Stable/A-1+) resulted in a large parliamentary majority for the Labour Party, the government will face difficult policy trade-offs, given the country's constrained fiscal position, unless superior GDP growth materializes. The general government deficit was 6% of GDP last year, while gross debt was slightly above 100% of GDP—the highest in decades. Because this limits the government's ability to borrow, we expect the new administration will commit to reducing budgetary deficits and cutting government debt as a percentage of GDP.

What Could Change

Despite, or perhaps because of, still favorable financing conditions, there has been a relatively loose fiscal approach among large developed-market sovereigns in the last few years. For now, we don't expect notable budgetary consolidation to happen, broadly speaking. We think only a sharp step-up in market pressures could persuade governments to implement a more resolute budgetary consolidation. That said, a sharp deterioration of borrowing conditions would also increase the size of the required fiscal adjustment, making necessary moves even more painful.

We generally think the EU's fiscal rules, and the possibility of an EDP, can provide a fiscal-policy anchor in member states and incentivize governments to comply.

We will continue to focus our sovereign ratings analysis on each individual country's fiscal trajectory, rather than on EU thresholds and regulations. We think that fiscal performance ultimately depends on national economic factors and individual governments—including their ability and will to comply with the rules. That compliance may, in turn, rest on the stringency or flexibility of the European Commission—in tandem with the European Council—in enforcing the rules.

Overall, our sovereign ratings reflect the wealth of a country's economy, the depth of its capital markets, its monetary and external flexibility, and its institutional effectiveness.

Large, developed economies finance themselves in reserve currencies and benefit from a large pool of domestic savings. This, alongside almost no foreign-currency debt, has enabled G-7 countries to refinance their rising debt burdens even during policy shifts. Also, advanced economies tend to have a track record of managing political, economic, and financial-sector turmoil.

In practice, G-7 governments generally respond in a timely fashion to market pressures, not least because any increase in their cost of capital pushes up borrowing costs for companies and households. These capabilities tend to endure, and when they do change, they do so only slowly, which underpins the stability of our sovereign ratings.

Nevertheless, there's been a steady weakening of creditworthiness among developed economies in the last two decades. As of July 16, we rate only 11 of 137 sovereigns 'AAA', and only two of these (Canada and Germany) are in the G-7, versus five in 2005. Today, the average rating on G-7 sovereigns is 1.5 notches lower than it was in 2005, and the average rating on euro area sovereigns is two notches lower. That said, since the COVID pandemic and oil-price shocks, we've downgraded only one G-7 sovereign: France, on May 31.

What does this imply for G-7 sovereign ratings going forward? Even the wealthiest countries can't carry an unlimited amount of debt without becoming vulnerable to interest-rate shocks, weaker growth, and/or the inflationary effects that come with economic overheating. The risk is that complacency around fiscal policy in G-7 economies becomes entrenched to the degree that it weighs further on ratings.

Long-term spending pressures are mounting for G-7 sovereigns. Aging populations are driving up spending on pensions and health care, without the benefit of offsetting improvements in productivity. Defense spending is also on the rise worldwide. NATO members falling short of the 2% GDP military-spending target include Canada, Italy, Portugal, and Spain, while a possible reduction in U.S. assistance to Ukraine would require stepped-up spending across the EU. Other public spending pressures stem from investments in green-energy transitions and the digitalization of European economies, although these could pay off in the form of higher growth over the long-term.

Writers: Molly Mintz and Joe Maguire