Long-term concerns about the stability of the Eurozone and the public finances of its member states have intensified recently due to the pandemic and its devastating effects on the economy.

Various institutional improvements and support mechanisms have been introduced since the global financial crisis. These include the creation of the European Stability Mechanism (ESM) and the 2020 Recovery and Resilience Facility (RRF) agreement, which provides financial support to vulnerable member states.

The ECB has shown its willingness to do whatever it takes to maintain the financial stability of the Eurozone through large-scale asset purchases under various programs, including the current Pandemic Emergency Purchase Program (PEPP). Following an increase in the initial wave of COVID-19 in the spring of 2020, performance spreads within the Eurozone have remained relatively low and stable since then.

While the chances of another sovereign debt crisis have diminished due to the above changes, there is still cause for concern, due to the high public debt-to-GDP ratios following the COVID-19 shock. Six euro area member states have ratios above 100%.

Debt-to-GDP ratio is not the only measure of sustainability. As long as interest costs remain low, the increased debt-to-GDP ratios can be maintained for some time. However, a sudden loss of investor confidence and rising financing costs can quickly destabilize the situation, with far-reaching consequences for economic and financial stability.

While the Eurozone now has various support mechanisms to mitigate the negative effects, formal macroeconomic adjustment programs would be required. Governments will be extremely reluctant to accept such programs if there is no constant market pressure.

The ECB has been committed to provide extensive political support for a while, extending the favorable combination of low interest rates and economic recovery. PEPP asset purchases are growing in the short term and will continue until at least the end of March 2022 in line with ECB guidelines. The reinvestment of major payments from assets that expire under PEPP program will continue until at least the end of 2023.

But then, assuming the ECB will want to start narrowing its huge balance sheet, the situation will become much more volatile, requiring fiscal consolidation strategies from most indebt member states. If governments do not show the ability and willingness to make these adjustments and the ECB does not recede, the situation could derail and lead to another crisis within the Eurozone.