Although euro area fiscal deficits and government debt remain above pre-pandemic levels, a debt crisis is unlikely in the next few years. However, in the medium term, most euro area countries will need to implement reforms to ensure sustainability, which will prove contentious. At nearly 90% of GDP, euro area government debt is high but lower than in other large economies such as the United States (120% of GDP) and Japan (255% of GDP). The sharp, COVID-induced economic downturn, which translated into higher spending and lower revenues, significantly increased fiscal deficits and debt ratios. However, high nominal GDP growth in 2022-23, including a major spike in inflation, helped reduce euro area debt from a peak of 97% of GDP in 2020 to 90%, despite the bloc's disappointing economic growth performance recently. This compares with a pre-pandemic debt level of 84% of GDP. The aggregate debt level disguises significant intra-euro differences, which are reflected in different levels of sovereign credit and default risk among the 20 members of the currency area.

• According to the rating agency Standard & Poor's, of the 20 euro area members, Germany, Luxembourg and the Netherlands have the highest sovereign credit ratings at AAA, while Greece and Hungary have the lowest rating at BBB-, which is equivalent to the lowest investment grade rating.
• The debt ratio is highest in Greece (170% of GDP) and lowest in Luxembourg (28% of GDP). However, Greece's debt ratio is lower today than before the pandemic when it stood at 186% of GDP. By contrast, at 110% of GDP, France's debt ratio is 12 percentage points higher today than it was before the pandemic; at 143% of GDP, Italy's ratio is 9 percentage points higher; and at 66% of GDP, Germany's is 6 percentage points higher than in 2019.
• For the euro area as a whole, the cyclically adjusted fiscal balance deteriorated from a surplus of 0.7% of GDP in 2019 to a deficit of 4.4% of GDP in 2020, but is estimated to have fallen to 3.3% of GDP in 2023. The International Monetary Fund (IMF) projects the euro area deficit to stabilize at around 2% of GDP during the second half of the decade. This, in aggregate, is consistent with a stable debt ratio of less than 100% of GDP.
• There is also significant intra-euro-area variation in terms of deficits. Fiscal deficits in Germany and Greece are projected to be around 1% of GDP over the next few years, while France's deficit is expected to average 3.5-4.0%; Italy's deficit, meanwhile, is set to decline from almost 5% of GDP in 2023 to just below 3% by 2028. In March, France announced that it would overshoot its targeted 4.9% of GDP deficit in 2023 by a substantial margin, while Italy's fiscal deficit reached a much higher than anticipated 7.2% of GDP in 2023, compared with its 5.3% of GDP goal.

In the short term, the institutional reforms of the past decade and a half will limit the risk of major financial distress by providing the euro area with adequate tools to prevent a liquidity crisis from spiraling into a solvency crisis, which will, in turn, buy distressed countries more time to adjust their policies. Originally designed without a financial backstop, the euro area has undergone a dramatic institutional evolution over the past decade and a half. The reforms have created a potentially infinite liquidity backstop provided by the European Central Bank in the form of multiple bond-buying programs. They have also established a bailout fund in the guise of the European Stability Mechanism (ESM), which allows distressed euro members to tap into emergency funds to prevent a liquidity-driven default in the context of policy adjustment and conditionality. The reforms also updated the original Stability and Growth Pact (twice), renamed Fiscal Compact, which provides for greater transparency and surveillance and sets more specific commitments to bring national fiscal policy in line with mandated targets. In addition, the euro area took steps toward a banking union to prevent banking sector instability from causing sovereign distress. Taken together, this new institutional framework limits the risk of sovereign and systemic banking sector distress. However, the euro area does remain an ''imperfect'' monetary union due to limited resource transfers and insufficient joint resources to backstop its banking sector, even though neither of these is strictly necessary to ensure the long-term viability of the common currency. 

• The European Central Bank has established various facilities that allow it to intervene in government debt markets, limit market volatility and even put a lid on long-term interest rates. Outright Monetary Transactions (OMT), established at the height of the euro area crisis in 2012, allows the central bank to make unlimited purchases in secondary government debt markets (under certain conditions). Various other facilities are geared toward quantitative easing, allowing for the purchase of public and private debt securities, such as the Pandemic Emergency Purchase Programme (PEPP, established in 2020), as well as toward guaranteeing the effectiveness of monetary policy, even if in practice these tools also help limit the risk of sovereign distress (such as the Securities Markets Programme, established in 2010; the Expanded Asset Purchase Programme, established in 2015; and the Transmission Protection Instrument, established in 2022).
• Established in 2012, the European Stability Mechanism provides the euro area with financial resources to bail out distressed member states and provide financial support to backstop banking sector crises. The fund has a lending capacity of 500 billion euros, and has 200 billion euros in reserves.
• The European Union's Fiscal Compact commits member states to actionable fiscal targets, as well as automatic corrective action, including a balanced budget rule and a debt brake rule that are embedded in domestic law. It also creates surveillance and transparency. 
• The European Central Bank supervises systemically important banks, while the ESM provides a financial backstop in case of banking resolutions. The euro area also has a separate bank resolution regime for systemically important banks.

In the long term, the prospect of higher interest rates in the context of continued subdued economic growth and increasing non-interest spending pressures will require further fiscal adjustment in order to ensure long-term debt sustainability in the euro area. The near-term outlook will be manageable for eurozone countries, thanks to an underlying fiscal stance that is broadly consistent with stable or only slowly increasing debt ratios in the currency area's financially weaker countries. Economically speaking, long-term debt dynamics are a function of real economic growth, real interest rates and the underlying (structural or cyclically adjusted) fiscal stance. Assuming a long-term real interest rate on government debt of 1% and a real GDP growth rate of 1%, euro-area governments need to generate a primary (before interest) fiscal balance of at least zero to stabilize their debt ratios. The primary deficit in 2023 was 1.7% of GDP, but the IMF projects the primary deficit to fall to zero by 2028, which, based on the above assumptions, would translate to a stable debt-to-GDP ratio after 2028. However, all euro area countries will have to expand government spending in the years ahead, in order to meet the rising pension and healthcare needs of their aging populations, as well as their climate transition and defense spending goals. Stabilizing the debt ratio over the long term will thus require either raising taxes or stabilizing non-interest expenditure as a share of GDP. This, in turn, will require politically painful domestic economic and financial reform. It will also lead to increased disagreement and tensions within the euro area over risk sharing. Countries with worse underlying economic fundamentals (like France and Italy) will need to pass more extensive reforms than countries with debt levels that are set to decline in the coming years (like Germany). This means that the euro area as a whole is not going to go insolvent, provided that the currency zone's financially stronger members are willing to support the weaker ones.

• Healthcare spending will add, on average, more than 1% percentage point of GDP to euro area government spending for the remainder of the decade. In light of increasing geopolitical conflict, defense expenditure can be assumed to increase 0.5-1.0% of GDP. Viewed from this perspective, the IMF's projections look somewhat optimistic, and will certainly not hold long beyond the Fund's forecasting horizon of 2028. Governments whose debt is projected to stabilize at current levels (e.g. France and Italy) will have to make difficult choices if they want to prevent debt ratios from increasing continuously, while countries with debt ratios that are either low (e.g. Baltic countries) or are set to decline (e.g. Germany) will face far less pressure and will enjoy greater policy flexibility.

Continued disagreements over issuing joint debt and creating a euro-area deposit insurance scheme will continue to prevent significant institutional progress and leave the eurozone more vulnerable to systemic economic and financial shocks than economies with a more streamlined institutional framework and effective systemic financial backstop. There exists a sharp divide between ''creditor'' countries with strong public finances, and ''debtor'' countries that are at significantly greater risk of experiencing financial distress, largely on account of their higher debt levels. Debtor countries in the euro area want more risk sharing, but creditor countries are reluctant to do so as they fear one-sided risk sharing and concomitant one-way resource transfers. Creditor countries prefer that risky countries assume the risks and costs of their own actions, and are only prepared to share risks if it helps increase systemic stability at limited potential costs. Debtor countries prefer to share risks with financially weaker countries. Negotiations over further reform aimed at increasing systemic stability and resilience will require a compromise between these two camps on how to allocate the potential costs of further risk sharing. Short of a crisis that requires further reform to preserve the monetary union, only limited and gradual institutional progress will be made in the next few years. However, the current framework goes a long way in terms of limiting the risk of sovereign distress, as well as mitigating the effects of sovereign distress.

• By 2028, Cyprus, Germany, Ireland, Luxembourg, Malta, the Netherlands, and the Baltic countries (Estonia, Latvia, and Lithuania) will have debt ratios below 60% of GDP. By contrast, Belgium, France, Greece and Spain will continue to have debt ratios of more than 100% of GDP. In Austria and the Netherlands, debt ratios will remain stable. This will help draw the ''battle lines'' in terms of economic policy and institutional reform, as the need for reform — and, in turn, the demand to share risk in the euro area — will be greater in countries like Belgium, France and Spain due to their less favorable debt dynamics. 
• Creditors are in principle prepared to provide greater financial resources toward establishing a common deposit insurance, for example, but only if national banking sectors are de-risked first in order to eliminate legacy risks. This, in turn, is unacceptable for governments that financially strongly rely on their banks to buy their debt (like Italy), and where ''de-risking'' would cause significant financial costs to both the national banking sector and the government. 
• Calls from more highly indebted countries like France and Italy for greater joint issuance of debt will not be heeded by more financially and fiscally sound countries with lower debt levels, unless there is another major emergency (akin to the COVID-19 crisis) or a risk of severe eurozone destabilization. This is also why only very limited progress will be made in terms of further strengthening the euro area institutionally.
• The 2023 reform of the European Union's Fiscal Compact sought to adjust some of the rules and reduce their complexity without fundamentally changing, loosening or tightening the frameworks. Extensive changes would have required changing the EU Treaty, which was neither practical nor feasible and suggests that the debtor-creditor division remained strong.