Spanish Banking Association (AEB) Economic Advisory Area
Economic and Financial Report September 2013
Situation, policies and outlook of the Spanish economy
Two years after the economy relapsed into recession, and with something of a lag behind rest of the euro area, the Spanish economy is starting to show signs of improvement, paving the way for the recovery. Not only is the external sector performing well, but private consumption has stabilised and there has been a tentative increase in investments in capital goods. The rate of job losses continues to slow, and there has been a slight drop in the unemployment rate. Recent indicators confirm stronger spending and activity, together with increased confidence among consumers and businesses. The drop in the sovereign risk premium, the reopening of the markets, the return of foreign investment, and rising stock market indices support this assessment. This change in trend, of which the strength and duration remain to be seen, is the response to Spain's correcting its basic imbalances, the adoption of structural reforms, and the easing of tensions in the euro area's financial markets.
From the domestic angle, the competitiveness gains from falling relative unit labour costs (internal devaluation) stand out, which have translated into a significant contribution from the external sector. The current account deficit has been corrected to the point that it is in surplus, and despite the backdrop of a recession, the general government primary structure deficit has been substantially reduced. In September the Troika confirmed that the financial sector support programme is on course and that banks' solvency is comfortable. The adjustment in the property sector, in terms of both volumes and prices, has continued apace, to the extent that institutional investors are now showing renewed interest. Deleveraging has continued in the private sector, but debt levels remain high. As regards structural policies, the labour market reform, the containment and rationalisation of public expenditure on the various levels of government, together with the measures aimed at liberalising goods and services markets (Unit of the Market Law, De-index-linking law, etc.) stand out. The agenda envisages measures in fundamental areas such as the pensions system, public administration, and the tax system. The main causes for concern are the high levels of unemployment and public debt, and the interest burden the latter generates.
Significant measures have also been taken by the European Union. One key initiative is the design of Banking Union, which, starting out from a single supervision system for the euro area headed by the ECB –expected to be in operation in the autumn of next year– will need to be backed up with a common resolution and deposit insurance mechanism. These are the three fundamental pillars to ensuring the viability of monetary union, reversing market fragmentation, re-establishing monetary policy transmission mechanisms and ensuring a free flow of credit. In view of the depth of the deterioration in the economic situation, the European Union has extended the deadlines for compliance with the budgetary targets and has adopted measures to support activity. Over the longer term, the authorities have confirmed their commitment to take steps towards fiscal, economic and political integration as necessary steps to guarantee the viability and satisfactory functioning of the euro.
The opportunity now exists to capitalise on these assets to build a more solid and sustainable recovery that is capable of bringing employment growth. The outlook for a stabilisation in households' real disposable income, in conjunction with increased consumer confidence and the need to release the pent-up demand contained during the recession, leaves the way open for a steadier pace of private consumption. The upturn in activity, improved earnings, and the need to upgrade equipment, should consolidate the incipient recovery in capital goods investments. In the property market, the adjustment in both price and volume terms points to its becoming less of a drag on growth, and job losses slowing. The external sector, now more competitive and benefiting from a gradual recovery in the euro area, will continue contributing to GDP growth, although less vigorously than in the past due to stronger domestic demand and rising imports. The anticipated improvements in borrowing conditions will also play an important role. In this scenario, the dynamics of multipliers will come into play, with positive effects on the various segments of spending, activity and employment, which will help restore the public accounts to health, deleverage the private sector, and enable credit to flow as required.
It is against this backdrop that the macroeconomic framework was drawn up by the government in its bill for the 2014 General State Budget. The Spanish economy will start growing in the second half of this year, yielding an average year-on-year contraction in GDP of 1.3 percent. Next year the drop in domestic demand will slow considerably –from 3.2 percent to 0.4 percent– while the external sector will continue contributing to GDP growth, albeit less strongly –from 1.9 to 1.2 percent. Within domestic demand, both private consumption and gross fixed capital formation will start to register positive progress –from -2.6 to 0.2 percent in the former case and from -6.1 to 0.2 percent in the latter.
Measures to make the labour market more flexible, wage restraint, and improved competitiveness, will make net job creation possible for the first time in five years from 2014 onwards, which in conjunction with the shrinking labour force, will bring down the unemployment rate, although it will still remain close to 26 percent. As regards inflation, the forecasts suggest a rate of 1.3 percent, and the De-index-linking law will make a big contribution to improving stability and enabling proper price formation. The current account surplus will continue to grow, to reach 3.4 percent of GDP, allowing external debt to be reduced. Finally, although not free from difficulty, the inescapable need to meet the budgetary targets will be helped by this context of increased activity. Unlike the case in previous years, these forecasts are close to those of most analysts. Only the IMF has taken a more pessimistic view, and has gone against the consensus view to predict growth of just 0.2 percent in 2014.
This diagnosis in no way supposes that the crisis is over or that there are no major risks ahead. The current improvement in the situation should be looked upon as an opportunity to break out of recession and start on a lasting and sustainable path to growth that is able to generate net employment so as to bring the economy closer to its true potential. It is therefore necessary to maintain a policy geared towards macroeconomic stability and extend the structural reforms in order to step up growth potential by making more exhaustive and efficient use of the factors of production (i.e. raising both employment and productivity). In the budgetary sphere, the room for manoeuvre in the short term is very limited, in that it is essential to stick strictly to the targets set, such that there is almost no scope for adopting an expansionary spending policy or increasing the tax burden. However, there is space to address wide ranging tax reform to lighten the burden on businesses and push forward general government reform from the perspective of rationalisation and efficiency criteria.
Madrid, 8 October 2013