Published Date: August 6, 2025
Author: HANetf
NATO to target 5% of GDP defence spend – At the NATO Summit in the Hague, on 24th and 25th of June, allies made a commitment to spend 5% of GDP on defence. They will allocate at least 3.5% of GDP annually based on the agreed definition of NATO defence expenditure by 2035 to resource core defence requirements to meet NATO Capability Targets. They will also target an additional 1.5% of GDP annually toward non-traditional areas of defence such as cyber security, critical infrastructure, and future of defence technologies. These new levels of spending mark a significant increase from the 2% of GDP targets set back in 2014 as part of NATO’s Wales Defence Investment Pledge. At the NATO Summit, the U.S. also reassured its commitment to the Article 5 mutual-defence provision.
Eastern European nations, Finland, and Germany lead NATO spending – It is no surprise that the European countries in closest physical proximity to Russia have some of the highest levels of spending as a percentage of GDP, led by Poland (set to spend 4.7% this year), Estonia (on target for 5.4% by 2029), Latvia, Greece, and Finland. No less significant is Germany, for years one of the worst defence spending laggards given its economic size. Germany is taking its spending level to 3.5% of GDP by the end of the decade. Germany’s new chancellor, Friedrich Merz, has declared that the Bundeswehr must “become the strongest conventional army in Europe,” not to do the U.S. a favour, but because Russia is an active threat to the entire region. All NATO members agreed to raise their defence spending thresholds from 2-5% of GDP, except for Spain which opted out of the new threshold, saying it can meet its military requirements for NATO by spending just 2.1% of GDP.
Global military spending to increase global debt load – According to a recent IMF assessment, global public debt is expected to rise by an additional 2.8% of GDP this year. Europe saw the largest increase in military spending in 2024, as its collective outlays rose by nearly one-fifth. A major credit rating agency said in February that bigger deficits in a rearming Europe seemed inevitable, due not just to higher interest rates but also a concurrent need to financially support some of the world’s oldest populations. Allowing European Union governments to trigger escape clauses that permit them to blow past designated borrowing limits seems necessary but is not without long-term debt consequences.
Europe’s defence spending shortfalls – Scope Ratings, one of Europe’s leading sovereign credit rating agencies, warned that NATO’s higher defence spending target of 3.5% of GDP risked sharply increasing budget deficits and public debt across the EU, putting sovereign credit profiles under significant strain. Scope Ratings delivered a stark warning over the fiscal impact of NATO’s revised defence spending target, cautioning that EU member states face mounting credit risks unless they implement difficult budgetary adjustments. In absolute terms, Germany’s defence spending shortfall stood out as the largest, estimated at around $106bn annually after the depletion of the €100bn special fund. This figure was more than twice the estimated shortfalls of Italy ($46bn), France ($45bn), the United Kingdom ($41bn) and Spain ($37bn). Luxembourg’s Prime Minister supports calls for the EU to issue joint debt to fund defence spending and climate change initiatives. The EU implemented common financing previously under COVID.
Top countries by military budgets in 2025 – The U.S. military budget in 2025 ($962 billion) remains the largest in the world – almost four times that of second-place China ($246 billion). But defence spending is rising across every region, with double-digit percentage jumps in Europe and the Middle East as conflicts in Ukraine and Gaza continue to reshape security priorities. Two ongoing wars and intensifying geopolitical risks, ranging from great-power rivalry in the Indo-Pacific to flare ups in the Middle East mean defence spending is skyrocketing this year. In Europe, Germany and the UK lead in terms of absolute budget. Germany’s combined core budget and special modernization fund push Berlin’s 2025 defence bill to roughly €100 billion ($109 billion), while the U.K. crosses £64 billion ($81 billion).
In the Indo-Pacific, China’s 7.2% budget increase keeps pace with its economic growth, while Japan ($55 billion) and Australia ($34 billion) accelerate long-range-strike and submarine programs designed to counter Beijing’s maritime threats. India, already the fifth-largest spender at $79 billion, plans to direct one-third of its capital budget to domestically produced systems under its “Make in India” push. China envoy encouraging Australia to resist U.S. pressure – Australia currently spends a little over 2% of GDP on defence and is being urged by the U.S. to raise that level to 3.5% of GDP. In response, China sent an envoy to Australia arguing that a ramp up in spending would be economically detrimental and that the “so-called China threat narrative” is overhyped. Australia and China are trading partners, and it is also trying not to antagonise Beijing. Australia’s Labor government has managed to rebuild ties with Beijing after they plunged into a deep freeze, which included punitive trade actions against some Australian goods in 2020.
Data as of 30.06.2025. Sources available upon request.
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Macro Outlook – NATO committed to 5% of GDP spend at the expense of other areas All NATO counties, with the exception of Spain, have committed to spending 5% of GDP, 3.5% on traditional military equipment with 1.5% of GDP on non-traditional military expenditures such as cyber security, critical infrastructure, and new technologies like robotics, AI, quantum, and autonomous vehicles. While the U.S. can claim victory in pressing Europe to fund its own defence at a level commensurate with U.S. spending, it also forces a situation in which Europe will be less reliant on the U.S. as well, with Europe building up local capabilities to close technology gaps. While this will not occur overnight, U.S. defence contractors will be disadvantaged in this scenario as Europe wants to spend at least 65% on European equipment as part of its “ReArm Europe” Plan. Europe will also need to either make budget cuts in other areas or take on debt to fund future defence expenditures. Several countries are reducing their Official Development Assistance (ODA) budgets including the Netherlands, France, Finland, and Belgium. These cuts are occurring amidst discussions about the EU’s long-term budget and calls for increased investment in areas like defence amid funding constraints. As a whole, the EU is planning to slash funding to the world’s poorest countries by 35% over the next three years, funding constraints supporting Ukraine and building up Europe’s defence- security capabilities.
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