The post-Cold War ‘peace dividend’ has come to an end as countries across the Emerging Europe region ramp up defence spending, says a new European Bank for Reconstruction and Development (EBRD) report. Defence spending in the region has surged in the past decade, putting pressure on public finances, the development bank warns. 

The report was published shortly before a public row between US President Donald Trump and Ukraine’s Volodymyr Zelenskiy at a White House press conference on February 28. 

Trump’s position triggered an urgent rethink of foreign and defence policy by European leaders, with European countries expected to ramp up defence spending significantly over concerns Trump’s US may pull back from its security commitments. Specifically, there are fears that the US may not come to the defence of its Nato allies in case of an attack by Russia. 

According to a note from JPMorgan, cited by Reuters, analysts anticipate that a substantial number of Nato’s 30 European members will soon pledge to boost their defence budgets considerably. Nato now includes most of the countries in Central and Southeast Europe from Estonia down to North Macedonia. 

But the average defence budgets in countries in the EBRD’s countries of operations — spanning Emerging Europe, Central Asia and the Southern and Eastern Mediterranean (Semed) — have already almost doubled in a 10-year period, climbing from 1.8% of GDP in 2014 to approximately 3.5% in 2023, according to data published by the EBRD its latest Regional Economic Prospects report. 

With the ongoing war in Ukraine and conflicts in the Middle East, as well as a ramping up of military capacity regions such as the Western Balkans and South Caucasus, this trend is set to continue, placing mounting strain on government finances already stretched by ageing populations and post-pandemic debt burdens.

“This comes at a time when government budgets are already stretched by servicing debts inherited from the COVID-19 period and under pressure from defence spending," EBRD chief economist Beata Javorcik said in an interview with bne IntelliNews ahead of the report’s release. 

At the same time as countries increase defence spending, US interest rates are projected to higher for longer, which will have an impact on global borrowing costs. 

The sharp increase in military expenditure comes as the so-called “peace dividend” – the reduction in defence spending that followed the Cold War – erodes in the face of rising security threats.

According to the EBRD’s analysis, Ukraine now allocates 37% of its GDP to defence, far outstripping any other economy in the region.

Nato’s eastern flank countries, including Poland, Latvia, Estonia, and Romania, have ramped up their military budgets in response to regional security concerns.

However, it is not only the countries facing a potential threat from Russia that have increased spending. Some of the highest increases were in Lebanon and other parts of the Middle East and North Africa. Armenia and Azerbaijan, which have been locked in a bilateral conflict for decades, have continued to spend heavily on armaments. Similarly, Serbia has increased military spending amid an upward trend across the Western Balkans, as has Kyrgyzstan, which has been involved in multiple border clashes with its neighbour Tajikistan. 

This surge in military expenditure comes at a time when several countries in the EBRD’s region of operations have relatively high levels of debt. The report singles out Lebanon, Mongolia, Tajikistan and Uzbekistan as countries that continue to rely heavily on short-term and US dollar-denominated bonds, exposing them to refinancing risks amid tightening global financial conditions.

The EBRD report highlights that the average general government balance in its regions deteriorated by around 2.2 percentage points (pp) between 2017-19 and 2024. These deficits are expected to persist into 2025, mirroring trends in advanced economies such as the US, France, and Germany.

With governments seeking to boost defence spending, long-term growth prospects may be at risk. "If defence spending is seen as a must, and if cutting social spending is very hard politically, what’s going to be crowded out is investment into education, R&D, and infrastructure — meaning all the spending that builds the foundation for future growth," Javorcik warned.

Despite the fiscal squeeze, there is little indication that governments will curb military spending in the near term. Many 2025-26 budgets already anticipate further increases, suggesting that defence will remain a priority even at the expense of other critical investments.

The EBRD’s analysis finds only a weak relationship between a country’s fiscal space – measured as a smaller deficit excluding defence spending – and its level of military expenditure, indicating that geopolitical concerns are the primary driver rather than fiscal prudence.