Spanish Banking Association (AEB) Economic Department
Economic and Financial Report July 2014
Adjusting imbalances and recovery
The Spanish economy has been on the upward phase of the cycle since the middle of last year, with three consecutive quarters of growth, and net job creation has been registered for the first time since the start of the crisis. This turning point is reaping the fruits of internal adjustments, banking industry restructuring, and the easing of financial market tensions in the euro area.
The competitiveness gains deriving from unit cost containment (internal devaluation) and the far-reaching restructuring of the banking system have played a decisive role, and Spain has successfully exited the financial assistance programme after meeting the requirements of the Memorandum of Understanding (MoU). Looser monetary conditions and progress on the construction of Banking Union in the euro area have allowed investor confidence to return and made finance available at affordable rates. Today’s conditions give grounds for optimism that the current recovery will be able to steadily gain traction. The broadening of the structural reforms, in order to enable more efficient resource allocation and unlock latent growth potential, would accelerate the pending adjustment to the imbalances while boosting capacity for growth and job creation.
The outlook is also conditional upon monetary policy and the progress made by the euro area's financial architecture. Despite the significant achievements, there is still a degree of market fragmentation and monetary policy transmission mechanisms are not working effectively. In any event, monetary policy cannot be asked to do the impossible, so it needs to be backed up with budget policies, structural reforms, as well as demand stimulus in economies that have the necessary leeway for it. The recovery in credit requires solvent demand and the implementation of cost-effective investment projects. If not, liquidity will remain bottled up in financial markets (fixed and variable income) with the risk of causing certain assets to become overvalued.
Another fundamental element is the banking system, where considerable progress has been made on restructuring, with significant improvements in its parameters measuring balance sheet health and solvency. The banks are now well positioned to confront the asset quality review (AQR) and stress tests planned for prior to their supervision by the ECB as of November. Banking Union will ensure greater transparency and a level playing field for institutions right across the euro area. However, the sector still faces major challenges: in particular, scant growth in credit demand, high default rates, and narrowing of margins accompanying the exceptionally low interest rates.
The outlook for the Spanish economy is one of continuing improvement accompanied by fresh upward revisions to the forecasts. For the current year, growth will be at a rate of close to 1.5 percent and is set to exceed 2 percent in 2015. Internal demand will continue to gain strength and will constitute the main driver of growth. Net job creation will pick up speed and the unemployment rate, benefiting from a contraction in the working population, may edge down to around 23 percent next year. Inflation will drop by a few tenths of a percent in 2014 and will stay below 1 percent in 2015. The external balance will remain at levels close to equilibrium although external debt will stay high. The targets for the public accounts, with a deficit reduction of 2.4 points of GDP between this year and next, are demanding and will require the adoption of additional measures if deviations arise. The burden of the public debt and interest payments remains high.
One priority is macroeconomic stability, which calls for compliance with the budgetary consolidation targets and a strengthening of Spanish firms’ competitiveness by combining internal cost moderation with productivity gains. The public accounts, with a structural deficit in which high tax levels are combined with low tax collection capacity, make more extensive tax reform necessary. In line with the recommendations of the Expert Committee, the European Commission and the IMF, the burden of direct and indirect taxes needs to be rebalanced, with a cut in social contributions (fiscal devaluation / employment tax) that, given their relatively high level, put Spain's firms at a disadvantage in both domestic and export markets. Other pending issues include public administration reform, based on rigorous austerity and efficiency criteria, and combating tax evasion. Supply-side policies require measures to strengthen competition in the goods, services and factors markets, stimulate industrial activity, and bolster Spain's firms' presence in their export markets. The 2012 labour market reform is beginning to bear fruits, but needs to be widened to boost its capacity to create employment and reduce labour market segmentation. More attention also needs to be paid to professional qualifications, which are a key factor in competitiveness.
Madrid, 15 July 2014