Geopolitical Fiscal Exposure: A New Lens for EU Fiscal Governance

Fiscal governance research has, for two decades, converged on a technocratic vocabulary – structural balances, output gaps, expenditure rules – built for a world in which the main source of variance in fiscal outcomes was the domestic business cycle. That vocabulary is increasingly strained. Within a single fiscal year, a small open economy can be simultaneously exposed to an armed conflict thousands of kilometres away that moves its energy import bill, an alliance commitment that raises its defence-spending floor and a contingent liability concentrated in a strategically sensitive state-owned enterprise – none of which are business cycle phenomena, and all of which are, in the vocabulary of international political economy (IPE), geopolitical.

This article develops a geopolitical fiscal exposure framework (GFEF) to make that observation tractable for fiscal governance and asks a more pointed question for European policy: what would it mean for EU fiscal surveillance – built, both before and after its 2024 reform, around cyclical adjustment logic – to take geopolitical exposure seriously as an explicit variable, rather than folding it into the residual of “temporary” or “one-off” measures? The claim is deliberately modest in form: not that public finance has become political science, but that its analytical toolkit is incomplete without an explicit accounting of energy, security and strategic-industry exposure.

A framework for geopolitically exposed fiscal governance

The structural budget balance remains the workhorse indicator of EU fiscal surveillance. Its cyclical adjustment procedure apportions all deviation from the structural target to two sources: discretionary policy and the output gap. Reforms since 2023 have shifted the emphasis towards expenditure rules and debt-sustainability safeguards, but neither the old nor the new framework has an explicit place for a shock whose transmission channel is geopolitical rather than cyclical. Treating their fiscal cost as “temporary”, as official statistics typically do, obscures rather than resolves the analytical gap.

Four strands of the IPE literature supply the building blocks for a more adequate model. Strange (1988) locates power in the international system in the structures – security, production, finance, knowledge – that condition what states and firms can do, rather than in observable bargaining outcomes alone. Kirshner (1995) shows that currency and monetary arrangements are themselves instruments of state coercion and vulnerability, a logic directly applicable to a small state’s exposure to externally driven energy-price and interest-rate shocks. Blackwill and Harris (2016) coin “geoeconomics” to describe the geopolitical determination of economic outcomes – precisely the mechanism by which an energy shock transmitted through armed conflict becomes a fiscal shock. Farrell and Newman (2019) show how networked economic interdependence creates chokepoints that states can weaponise; energy supply chains and defence-industrial commitments are two such chokepoints with direct fiscal transmission.

GFEF models the fiscal outcome of a small open economy in a given year as jointly determined by two conventional fundamentals (debt and the primary balance track record) and three exposure channels (energy dependence, security commitment and strategic industry exposure) conditional on the external shock. The two fundamentals determine a country’s fiscal space, which in turn determines its capacity to absorb a shock without recourse to unsustainable financing. Energy dependence captures the share of energy needs met through imports exposed to geopolitically driven price volatility; security commitment captures a state’s defence-spending trajectory as set by alliance membership rather than domestic threat assessment alone (for European economies, NATO’s 2% and emerging 3.5% of GDP targets); strategic-industry exposure captures the concentration of contingent liabilities – state-owned enterprises, public–private partnerships – in geopolitically sensitive sectors (energy, transport, semiconductors, defence). A shock’s fiscal footprint scales with these three channels and is dampened, but not eliminated, by fiscal space. The framework is conceptual rather than estimated at this stage; the two empirical sections below probe it qualitatively and, in the seven-country panel, semi-quantitatively through cross-country variation.

The article first sets out GFEF as an explicit, if qualitative, model before illustrating its mechanics through Portugal’s 2026 budget – a diagnostic case chosen because it combines, within a single fiscal year, a documented strengthening of conventional fiscal fundamentals with the simultaneous activation of two geopolitical exposure channels. The article then probes the framework’s external validity across a seven-country euro area panel exposed to a broadly common 2026 shock, before extending it, briefly and qualitatively, to five economies with sharply contrasting exposure profiles. It closes by asking what an explicit accounting of geopolitical exposure would imply for the EU’s own fiscal surveillance architecture, which is the article’s central policy contribution.

Portugal’s 2026 budget: The framework in action

Portugal offers a diagnostic illustration because it combines, within a single fiscal year, a documented strengthening of fiscal space fundamentals with two textbook exposure shocks. Portugal recorded a third consecutive annual surplus in 2025 (0.7% of GDP), and public debt fell below 90% of GDP for the first time in sixteen years (see Table 1). On exposure, the country absorbed a severe winter-storm shock (January-February 2026) and the energy-price shock transmitted by the escalation of the Middle East conflict, both incorporated into every major forecaster’s 2026 projection – the European Commission, the International Monetary Fund, the Organisation for Economic Co-operation and Development, Banco de Portugal and the Conselho das Finanças Públicas.

Table 1
Applying the geopolitical fiscal exposure framework to Portugal’s budget

A longitudinal comparison of original budget targets against realised outturns is diagnostic of how the balance between fundamentals and exposure has shifted. In every year between 2019 and 2025 for which a comparable target is documented, the realised outturn exceeded the target – a systematically conservative pattern consistent with low geopolitical exposure. In-year execution data for January-April 2026, published by the Unidade Técnica de Apoio Orçamental in June 2026, show a cash-basis deficit of €1,548 million, already exceeding the full-year deficit target embedded in the 2026 state budget (€975 million) after four months. This reversal – from systematic outperformance to in-year slippage – is consistent with GFEF’s prediction that a sufficiently large exposure shock can overwhelm even a strong fiscal space term.

It is worth being explicit about what GFEF is not claiming. It is not a substitute for the structural balance or for debt-sustainability analysis, both of which remain the correct starting point for assessing a country’s underlying fiscal position. Nor does it claim that every fiscal deviation has a geopolitical explanation – most do not, and the framework would be analytically empty if it did. Its claim is narrower and, the empirical sections below suggest, defensible: that a specific, identifiable subset of fiscal deviations is geopolitically rather than cyclically transmitted, that this subset is growing in salience for small open European economies, and that current surveillance practice has no vocabulary for isolating it from ordinary discretionary slippage.

A seven-country check

If GFEF has explanatory content beyond the Portuguese case, a common geopolitical shock should produce fiscal outcomes that track exposure and fiscal space fundamentals across other economies, not idiosyncratic national narratives. Table 2 compiles, from the European Commission’s Spring 2026 Forecast, a seven-country panel – Portugal, Ireland, Spain, Italy, France, Belgium and Greece – all subject to the same 2026 Middle East energy shock and rising defence-spending pressure, but differing sharply in fiscal space fundamentals.

Table 2
Fiscal space and 2026 fiscal outcomes in a seven-country euro area panel

The panel is consistent with GFEF’s core prediction: under broadly common exposure, the 6.6 percentage point spread in outcomes (from Ireland’s +1.4% to Belgium’s -5.2%) tracks the fiscal space term far more closely than it tracks any observable difference in shock exposure itself. Greece and Portugal, with strong primary-balance track records, outperform Italy, France and Belgium, whose fiscal space term is comparatively weaker. Ireland is a useful boundary case: its fiscal space is exceptionally strong by conventional metrics but rests on a narrow, concentrated corporate-tax base – a reminder that fiscal space itself has more than one source. This seven-country probe is descriptive rather than causally identified, but it rules out a purely Portuguese idiosyncrasy.

What this would mean for EU fiscal surveillance

Two implications follow for EU fiscal governance specifically. First, the reformed fiscal framework’s 2024 shift towards expenditure rules and debt-sustainability safeguards can be read as an implicit, if unacknowledged, move towards the fiscal space logic at the core of GFEF, since an expenditure rule lets shocks to revenue and to the cycle flow through to the budget balance rather than requiring offsetting adjustment, as a structural balance rule does (Bušs et al., 2024). That shift, however, remains incomplete: it changes how fiscal space is measured, but it still has no explicit mechanism for distinguishing a geopolitically driven deviation from a cyclically driven one. When a member state overshoots its expenditure path because of an energy-price shock transmitted by armed conflict rather than because of discretionary policy slippage, the current framework has no vocabulary for saying so – and the political cost of that silence falls asymmetrically on the more exposed member states, which is precisely the pattern the seven-country panel above documents.

Second, if GFEF’s exposure channels prove empirically significant – and the seven-country panel here is only a first, descriptive pass – EU fiscal surveillance may need something comparable to the cyclical adjustment procedure itself: an explicit accounting of energy dependence, alliance-set defence spending floors, and strategic-industry contingent liabilities, reported alongside the structural balance and the debt trajectory in each country’s Stability and Convergence Programme and assessed by the Commission and by national independent fiscal institutions such as Portugal’s Conselho das Finanças Públicas. This would not replace the existing framework; it would give the Commission, the Council and national fiscal councils a shared vocabulary for a category of shock – geopolitical rather than cyclical – that the current framework has no explicit place for, and that 2026 has made difficult to ignore. It would also give member states a more defensible basis for requesting the escape clause flexibility that the reformed framework already allows for exceptional circumstances. This is because geopolitical exposure channels, unlike a generic reference to “exceptional circumstances”, are ex ante observable and, in principle, quantifiable before the shock materialises.

A further, more speculative implication concerns the defence spending dimension specifically. As NATO’s defence spending targets rise from 2% towards 3.5% of GDP over the coming decade, member states with weak fiscal space terms, as Table 2 shows for France and Belgium, will face a structurally higher security commitment exposure than member states with strong fiscal space, such as Ireland or Greece, even though the underlying alliance commitment is nominally uniform across the euro area. A fiscal surveillance framework blind to this channel risks treating a structurally determined, alliance-driven expenditure floor as if it were ordinary discretionary spending subject to the same consolidation expectations everywhere – an equivalence that GFEF suggests is analytically unwarranted and that this article’s seven-country evidence, while preliminary, does not support.

The immediate research agenda is to build the country-year panel data needed to operationalise each channel – energy import shares weighted by price shock elasticity, defence expenditure relative to alliance-set floors, and the contingent liability stock of state-owned enterprises and public–private partnerships in a small set of geopolitically salient sectors – across, at minimum, the euro area. With such a panel, GFEF’s central prediction becomes directly testable with panel-regression methods, including interaction terms between a shock indicator and each exposure channel, and EU fiscal surveillance would have an evidentiary basis for deciding whether, and how, to formalise the distinction this article proposes.

Conclusion

Portugal’s 2026 budget shows a country with strengthening fiscal space fundamentals nonetheless recording an in-year execution reversal once two geopolitical exposure channels were simultaneously activated. A seven-country euro area panel shows this is not a Portuguese idiosyncrasy: under broadly common 2026 exposure, fiscal outcomes diverged by 6.6 percentage points of GDP, tracking fiscal space fundamentals rather than exposure itself. Rather than claiming that public finance has become political science, the more defensible claim is that contemporary fiscal governance in geopolitically exposed economies is increasingly shaped by variables that conventional macro-fiscal models – and EU fiscal surveillance in particular – treat as exogenous, and that a combined economics–IPE framework captures dynamics that cyclical adjustment methodology alone cannot.

For EU policymakers, the practical question this raises is not whether to abandon debt- and expenditure-based surveillance, but whether to complement it, for the subset of member states most exposed to energy, security and strategic industry shocks, with an explicit and comparable accounting of that exposure. The 2026 experience, documented here for Portugal and, more tentatively, across six neighbouring economies, suggests that question can no longer be deferred to the next crisis.

References

Banco de Portugal. (2026). Boletim Económico – Junho de 2026. Banco de Portugal.

Blackwill, R. D., & Harris, J. M. (2016). War by Other Means: Geoeconomics and Statecraft. Harvard University Press.

Bušs, G., Grüning, P., & Tkačevs, O. (2024). Choosing the European fiscal rule. Baltic Journal of Economics, 24(1), 116–144.

Conselho das Finanças Públicas. (2026). Perspetivas Económicas e Orçamentais (Relatório 02/2026, 15 April 2026).

European Commission. (2023). Communication on the reform of the EU economic governance framework.

European Commission. (2026). Spring 2026 Economic Forecast. Directorate-General for Economic and Financial Affairs.

Farrell, H., & Newman, A. L. (2019). Weaponized interdependence: How global economic networks shape state coercion. International Security, 44(1), 42–79.

International Monetary Fund. (2026). Portugal: 2026 Article IV Consultation. IMF Country Report, No. 2026/147.

Kirshner, J. (1995). Currency and Coercion: The Political Economy of International Monetary Power. Princeton University Press.

Ministério das Finanças. (2026). Relatório Anual de Progresso 2026.

Organisation for Economic Co-Operation and Development. (2026). OECD Economic Outlook, Vol 2026, Issue 1. OECD Publishing.

Strange, S. (1988). States and Markets. Pinter.

Unidade Técnica de Apoio Orçamental. (2026). Relatório sobre a execução orçamental das administrações públicas – Janeiro a Abril. Assembleia da República.