Rising defense spending across European NATO members in response to heightened geopolitical uncertainty is set to worsen fiscal deficits and strain national budgets, according to Fitch Ratings.
Since Russia’s invasion of Ukraine, nearly all European nations have boosted their military expenditures, but many still fall short of NATO’s 2% of GDP guideline.
European Commission President Ursula von der Leyen recently called for member states to increase their collective spending from just under 2% to over 3% of EU GDP.
The U.K. has committed to reaching 2.5% of GDP by 2027, with a long-term goal of 3%, partially funded by cuts to overseas aid.
While achieving a 3% target may be unrealistic for all nations in the near term, Fitch believes that an annual 1 percentage point (pp) increase in defense spending is plausible for many European countries, particularly after a ramp-up period of three to four years.
Fiscal pressure and rising debt concerns
Higher defense spending is expected to widen fiscal deficits, as governments struggle to make offsetting expenditure cuts amid aging populations, rising debt-servicing costs, and political resistance to tax hikes. Fitch anticipates that EU authorities may allow national escape clauses to prevent excessive deficit procedures (EDPs) from being triggered for nations increasing their military budgets.
The impact on sovereign credit ratings will vary based on fiscal resilience. Some European nations, such as Denmark, may absorb higher military spending without long-term debt implications, while others could see faster debt accumulation than currently forecasted.
Nations closer to Russia, such as Poland and Central and Eastern European (CEE) countries, have already significantly increased military spending, in some cases approaching 5% of GDP. However, countries further from the conflict zone may lag behind in scaling up their defense budgets.
EU financing options and special-purpose funds
The EU has historically relied on joint borrowing to mitigate the economic fallout from crises such as the COVID-19 pandemic.
Fitch predicts that some defense spending could be financed through European-level borrowing, possibly through a new special-purpose fund rather than a complex, EU-wide borrowing program like the NextGenerationEU (NGEU).
Such a special-purpose fund could allow non-EU NATO members, including the UK, to participate, potentially reducing the fiscal burden on individual countries. However, the effectiveness of any financing mechanism will depend on funding structures, sovereign commitments, and distribution mechanisms.
The European Commission is set to publish a White Paper on March 19, outlining plans for military investment and financing. It remains uncertain whether the proposal will include joint borrowing mechanisms to ease the financial burden on member states.
