In recent years, with the intensification of geopolitical tensions and the transition to green energy, the scale of debt accumulated by countries continues to accelerate. According to the European Central Bank, if the eurozone cannot reduce public debt, promote growth, and reverse "policy uncertainty," the eurozone will face the risk of another debt crisis.

According to the Financial Times, the ECB released its annual Financial Stability Assessment on Wednesday (November 20), warning that "market concerns about sovereign debt sustainability" may resurface.

The report states that "geopolitical and policy uncertainties have exacerbated sovereign fragility," and the European Central Bank has cited "election results at the European and national levels, particularly in France," as a factor that "reignites concerns about the sustainability of sovereign debt.

The report states, "Increased policy uncertainty and market concerns about the impact on its debt sustainability have led to widening spreads on some eurozone sovereign bonds with high debt levels, although cross-border spillover effects are currently limited. At the same time, the long-term trend of increased political fragmentation observed over the past three decades has made it more challenging to form a stable government alliance

The European Central Bank warned that these developments "may delay reaching an agreement on key fiscal and structural reforms, while also increasing uncertainty in economic policies

They added, "In addition, the rise in geopolitical uncertainty may mean additional burdens for sovereign states in dealing with geopolitical impacts such as energy subsidies. This is particularly challenging for countries with high levels of public debt, as their fiscal space to support the economy in the face of adverse shocks is limited

Luis de Guindos, Vice President of the European Central Bank, stated that another factor contributing to this issue is that some member state governments have had poor compliance with EU fiscal rules in the past.

De Guindos wrote, "In addition to geopolitical and policy uncertainty, global trade tensions are also intensifying, increasing the risk of tail events. Since the last issue of the Financial Stability Assessment, financial markets have experienced volatility and several significant spikes

He added, "In the eurozone, although inflationary pressures are subsiding, market participants are concerned that economic growth may be weaker than expected. So far, financial markets have shown resilience, and volatility has been proven to be short-lived with limited impact on the broader financial system. However, potential financial market vulnerabilities, particularly overvaluation and risk concentration, remain severe, making further volatility more likely than usual

He also pointed out that this is happening, "the liquidity vulnerability of non bank financial intermediaries, coupled with high financial and comprehensive leverage in some cases, may exacerbate and prolong market pressures. At the same time, sovereign fragility is deepening

Although the debt to GDP ratio has recently decreased, fiscal challenges still exist in several eurozone countries, exacerbated by structural issues such as weak potential growth and increased policy uncertainty. Although the non-financial sector appears to be resilient overall, some eurozone households and businesses have concerns about credit risk, particularly in the real estate industry, low-income households, and small and medium-sized enterprises (which will be most severely affected if economic growth slows down), "said de Guindos

The report provides a detailed explanation that the borrowing costs of certain countries, including Italy and Spain at the center of the eurozone crisis, are still far below their highs during the market turmoil of the early 2010s, but this has not stopped investors from worrying about the rapid rise in debt of other countries such as France.

In a conference call with reporters, de Guindos stated that the market has begun to "pay more attention to fiscal (risk)" and pointed out that "the financing costs of countries with debt to GDP ratios exceeding 100% have significantly increased in recent financial market fluctuations

According to the Financial Times, "the interest rate difference between French 10-year treasury bond and German 10-year treasury bond is an indicator of investors' worries about the former's debt. This month, it reached 0.78 percentage points, close to the 12 year high set on the eve of parliamentary elections this summer."

This fact has led the European Central Bank to warn that "factors such as low productivity have a negative impact on economic growth, causing debt levels to rise and budget deficits to be more likely to reignite concerns about debt sustainability

The report discusses various risks facing the region, and it is worth noting that its warning of fiscal risks is more prominent than previous versions, indicating that the problem is approaching a critical point. In its assessment for 2023, the European Central Bank pointed out that doubts about the sustainability of public debt may resurface, but stated that "the risks to sovereign debt sustainability seem manageable in the short term

De Guindos stated that the European Central Bank should "make it very clear that there are potential threats before us," including "potential contagion from other jurisdictions," referring to the policies issued by incoming US President Trump and the potential impact of rising US government debt on global markets.

The report also suggests that macroeconomic shocks may push up government financing costs, including weak fundamentals and the extension of maturing sovereign debt at higher interest rates.

The report warns that "interest costs will further rise and put pressure on government finances for many years to come, making timely fiscal consolidation increasingly necessary. Although the European Central Bank's policy interest rates and borrowing costs for eurozone governments are expected to further decrease, most eurozone countries' sovereign debt interest payments relative to GDP are expected to increase in the medium term and beyond

The report added, "This is because the average maturity of sovereign debt is 8 years, which is relatively long, so maturing public debt is still being extended at higher interest rates than a few years ago. The increase in interest payments will further limit the remaining fiscal space and make timely fiscal consolidation more important

As an example, the report cites estimates from the European Union that by 2034, France's interest payments will more than double, exceeding 4% of GDP, while Italy's interest payments will increase by nearly one-third, reaching 6% of GDP.

The report states, "Overall, although sovereign countries in the eurozone have benefited from the relaxation of the global financing environment since the end of 2023, their debt servicing costs will rise in the short term, especially for sovereign countries whose debt to GDP ratio has increased. In this context, the comprehensive, transparent, and timely implementation of the revised economic governance framework of the European Union will help governments to continuously reduce budget deficits and debt ratios

The European Central Bank also warned that the combination of low growth and high government debt may make it more difficult for governments to pay for increased defense needs and investments to address climate change.

The report warns that financial markets are still vulnerable to adverse factors, and the fragility of non bank liquidity may amplify these adverse factors

The European Central Bank stated, "Overvaluation and risk concentration make financial markets vulnerable to sudden and drastic adjustments, especially in the stock market. Although the stock market has recently quickly digested tail events, potential fragility makes it prone to similar events in the future. There are indications that investors may underestimate and underestimate the likelihood and impact of adverse situations, as evidenced by record low stock risk premiums and relatively compressed corporate bond spreads on both sides of the Atlantic

They added: "In addition, in recent years, the concentration of stock market value and earnings to a few companies has increased significantly, especially in the United States. This phenomenon has raised concerns about the possibility of foam in AI related asset prices."

The report warns that with the "deep integration of global stock markets", this concentration phenomenon "indicates that if the profit expectations of these companies disappoint, there may be adverse global spillover effects".

The report states, "Therefore, negative surprises are more likely to occur (including a sharp deterioration in economic growth prospects, sudden changes in monetary policy expectations, or further escalation of ongoing geopolitical conflicts), which may trigger a sudden shift in investor sentiment and generate spillover effects among various asset classes

The European Central Bank has warned that if a severe economic recession occurs, the balance sheets of banks and investment funds may also be hit, as eurozone consumers and businesses are already struggling to raise interest rates, which could increase the risk of increased losses in commercial real estate.

The report states, "In addition, several cross disciplinary structural issues remain crucial for financial stability, which may interact and amplify existing cyclical vulnerabilities. In the process of transitioning to a low-carbon economy, these issues are all related to climate related risks, including transition risks and physical risks; cybersecurity vulnerabilities, including disruptions in system IT providers, and the rise of artificial intelligence; and geopolitical fragmentation leading to a reversal in global economic, trade, and financial integration

The report concludes, "The possibility of these cycles and structural vulnerabilities occurring simultaneously and amplifying each other increases the risk of financial stability and may create adverse feedback loops in various industries