The years 2025 and 2026 were marked by intense geopolitical turmoil in the Middle East, with adverse worldwide effects on the cost of living and economic growth.

The policy responses of EU member states and the guidance provided by the European Commission, which is responsible for implementing the commonly agreed EU fiscal framework that imposes strict rules regarding deficits and public debt, are of particular interest.

According to Eurostat, the euro area government debt-to-GDP ratio stood at 88.9 per cent in early 2026, showcasing the scale of the fiscal pressures.

The continued fiscal expansion, in response to the successive crises from the coronavirus pandemic to the present, took place without major adverse macroeconomic effects.

This development, combined with the active and timely responses of central banks and the relatively mild reaction of financial markets, suggests that, currently and for various reasons, there exists greater fiscal space than is generally perceived.

As part of the effort to adapt to the conditions created by the geopolitical crisis in the Middle East, the European Council, the EU’s top institutional body, decided to leverage the flexibility of the budgetary framework.

Specifically, the activation of the escape clause was permitted to allow for a temporary deviation from the numerical fiscal targets, notably via increased defence spending up to a ceiling of 1.5 per cent of GDP and within a four-year horizon.

Currently, a temporary deviation for energy-related expenditure is also being considered, within the same overall limit.

The network of National Fiscal Councils, tasked with assessing the developments in the public finances of EU member states, has published its annual assessment of member states’ fiscal policies.

The report’s key findings highlight the fact that the framework, as implemented by most countries, raises legitimate concerns regarding the long-term sustainability of public finances.

Deviations from the targets are not deemed temporary – as they should be – while, from a long-term perspective, population ageing places further strain on public finances.

Furthermore, national fiscal councils consider that the macroeconomic forecasts in state budgets are often overly optimistic, distorting the true state of public finances.

These concerns are reflected in elevated long-term interest rates of government bonds, including those of major countries, such as France and even Germany, where 10-year benchmark yields have faced upward volatility amid persistent fiscal deficits.

Another key concern relates to the broad, untargeted measures adopted for supporting households and addressing the energy crisis. These measures are deemed fiscally costly and lead to persistent inflationary pressures, while also acting as a disincentive for the required energy conservation.

Based on the same report, the overall fiscal situation in Cyprus presents a favourable picture. Public debt is on a downward trend, which, based on current data, is expected to continue over the coming years.

In fact, Cyprus recorded one of the EU’s largest annual drops in public debt, with its debt-to-GDP ratio falling comfortably below the 60 per cent threshold to approximately 54.6 per cent in 2026.

The satisfactory performance of public finances offers an opportunity to channel resources towards addressing existing challenges, regarding the long-term viability and adequacy of pensions, as well as the energy and digital transitions.

Cyprus should not misuse the current opportunity by spending on the basis of short-term political considerations, but rather invest decisively in structural reforms that will safeguard the welfare of future generations.

Andreas Charalambous is an economist and Chairman of the Cyprus Fiscal Council. Omiros Pissarides is an economist and member of the Cyprus Economy and Competitiveness Council. The views they express are personal