Analysis: Extreme Weather Contributes to Fiscal Strains in Central Europe – Reuters

By Jan Lopatka, Karol Badohal, and Gergely Szakacs

PRAGUE/WARSAW – Just a week ago, prior to devastating floods affecting central Europe, the Czech Republic seemed poised to be the first nation in the region to successfully bring its budget deficit below the 3% of GDP limit mandated by EU regulations since the onset of COVID-19.

However, this potential achievement is now uncertain as both the Czech Republic and Poland, the hardest hit by the floods, assess the damage from what are deemed the worst floods in the region in over two decades.

Local officials estimate that infrastructure damages in these two countries could reach around $10 billion. Poland’s finance minister indicated that the $5.6 billion earmarked from EU funds would only address a portion of the recovery costs.

Economic losses linked to extreme weather are straining state finances in a region already grappling with the repercussions of the COVID-19 pandemic and the inflation surge following Russia’s invasion of Ukraine in 2022.

During the pandemic, EU member states suspended the requirement to keep annual deficits below 3% of GDP, leading to significant budget shortfalls—up to 9% of GDP in Romania and 7% in both Poland and Hungary.

Additionally, inflation and upcoming elections in Poland, Hungary, and Romania, accompanied by likely promises of increased spending, have further complicated efforts to reduce deficits.

Rising military expenditures, inflation-driven pension costs, and increased debt servicing expenses are additional factors putting pressure on national budgets.

On Thursday, the Czech finance ministry announced it would allocate 30 billion crowns (approximately $1.3 billion), or 0.4% of GDP, for flood-related damages in an amendment to the 2024 budget—25% more than the initial estimate provided by an economist earlier in the week.

This adjustment could potentially push the Czech deficit closer to the EU’s 3% cap, up from an original target of 2.5%, with projected deficits for the coming year also likely to exceed previous estimates.

Steffen Dyck, Senior Vice President at Moody’s Ratings, commented that while the region is better prepared for flooding than in the past, the frequency and economic impact of these incidents are increasing.

"There might still be an impact on government spending, depending on the ultimate damage, and some countries, like the Czech Republic and Poland, have already announced immediate emergency fiscal support," Dyck noted.

The financial challenges facing the Czech Republic underscore the broader dilemmas faced by other Eastern EU member states that are also contend with larger deficits, including Romania, which hovers near 7%, and Poland and Hungary, both over 5%.

LONG-TERM VIEW

A recent analysis of draft budgets and fiscal plans indicates that it might take Poland and Hungary most of this decade to manage their deficits below 3%, while Romania could remain above that threshold until the 2030s.

For Poland, the region’s largest economy, Moody’s forecasts general government debt could rise to 60% of GDP by 2027 due to increasing borrowing, which will escalate debt-related expenditures.

The Polish budget deficit is expected to exceed 5% of GDP by 2025, with only a "very gradual consolidation" anticipated toward a 3% target over the next four to five years.

With the costs of flood repairs looming, Poland is likely to seek more flexibility from the EU regarding its state finances.

Fitch Ratings recently commented that spending pressures in Poland were "greater than anticipated" following the presentation of its 2025 budget draft, although a robust revenue base continues to provide some support.

The floods have struck a region already affected by a sluggish German economy, which is a significant destination for 20-30% of Central European exports, potentially leading to long-term consequences for state finances.

"CEE growth prospects could suffer if Germany’s economic weakness proves structural and protracted," stated Karen Vartapetov, Director and Lead Analyst for CEE and CIS Sovereign Ratings at S&P Global. She added, "Weaker medium-term growth could pressure CEE public finances when government funding costs are already high."

Last year, debt servicing costs surged to 4.7% of GDP in Hungary and 2% in Poland and Romania, while the Czech Republic’s cost, at 1.3% of GDP, remained below the EU average—although nearly double the 0.7% seen before the pandemic.

Romania is yet to present its 2025 budget, as authorities consider a seven-year plan to rein in its deficit from some of the highest levels in the EU, with predictions suggesting it might reach up to 8% of GDP this year due to an expensive pension reform.

Hungary, which has maintained an average budget deficit near 7% of GDP since the pandemic, has committed to reducing it to 4.5% of GDP this year, though Moody’s anticipates it could be a full percentage point higher despite recent attempts to narrow the gap.