We thank Ms. Schaechter and her team for the candid dialogue held during the mission, for the congruence of views and for their hard work on the staff report, including the four selected issues papers. We agree with their assessment that bold structural reforms have laid the ground for Spain’s current recovery, and that it is essential to preserve them and continue to make further progress. We also agree with the many constructive and useful economic policy recommendations, which are broadly in line with the authorities’ goals.
Moreover, we are pleased that the staff report recognizes that “the priorities of the new government are preserving earlier reform achievements and meeting short-term fiscal commitments under the Stability and Growth Pact.” Although under a minority government, there is broad political consensus about several policy priorities and reforms that can support growth in the immediate future and more importantly, raise Spain’s growth potential to higher levels.
Throughout 2016 Spain continued the expansionary trend that started three years ago, outperforming the Eurozone and the world’s largest economies. Real GDP growth will be at least 3.2 percent in 2016, and by mid-2017 the economy should have recovered pre-crisis income levels. We agree with staff that growth forecasts for the subsequent years will remain over 2 percent despite some deceleration coming from milder tailwinds. The staff report correctly highlights that Spain has managed to achieve this “impressive recovery” thanks to sound economic policies and structural reforms which have contributed to raise short-term growth, growth potential and confidence. This economic turnaround has also allowed the ongoing correction of Spain’s main external and internal imbalances under a more sustainable growth model.
The 2012 labor market reform is a case in point. It improved labor dynamics, allowing for wage moderation and eventually lowered the GDP growth threshold for net employment creation from 2 percent to around 0.7 percent. In the last two years, more than 1 million net jobs have been created. Spain is currently creating around 500,000 net jobs per year on average, with employment growing at rates over 3 percent year-on-year since 2015. This recovery has driven down the unemployment rate by 8 p.p. from its peak, with youth and long-term unemployment continuing to fall. Moreover, as staff rightly acknowledges, job creation has helped to reduce inequality in Spain since 2014.
Measures to reduce duality and to make permanent contracts more attractive are paying off, as almost half of total job creation among wage-earners is already permanent. The prospects for the long-term unemployed keep improving, with flows out of unemployment gradually strengthening for this group.
We also agree with staff’s assessment that there is no room for complacency: job creation remains the key challenge for the Spanish economy. Staff correctly points out that it is essential to safeguard the reforms, and that there is scope to continue improving the functioning of the labor market, especially in the field of active labor market policies.
Spain is expected to record in 2016 a current account surplus for the fourth year in a row; never before in recent history had Spain experienced subsequent external surpluses, especially relevant in the context of high economic growth. The IMF expects a surplus of 2 percent in 2016, highlighting that “sustained and healthy export growth reflects regained competitiveness arising from price and wage moderation and larger firm’s internationalization efforts.” Net exports are currently contributing to economic growth, and the share of exports to GDP is almost ten percentage points higher than before the crisis. In fact, Spain has shifted from being a net borrower to a net lender, and will record in 2016 its fifth consecutive year with lending capacity to the rest of the world.
This accumulation of external surpluses is finally being reflected in the reduction of the negative NIIP despite adverse valuation effects. As these effects subside, and given that current account surpluses are expected to continue, the NIIP is set to improve further. Although we agree with staff’s views that this external vulnerability needs to be further addressed, a number of mitigating factors should be taken into account: the NIIP has a large debt related FDI component (20 percent of GDP), and significant large gross equity liabilities (60 percent of GDP); debt is mainly denominated in domestic currency and its maturity is predominantly long term; as for assets, they are diversified. Both staff and the authorities expect the NIIP to continue improving in the coming years.
The authorities agree with staff’s assessment on the financial sector: the banking system has gained further strength due to better asset quality, stronger capital and funding positions and reduced debt overhangs. The system is closer to putting most of the crisis legacies behind it and NPLs, which show a downward trend, are well provisioned. Furthermore, the dynamics of bank credit are supportive of private sector deleveraging, while facilitating new credit flows. Challenges ahead include the low profitability environment and new regulatory initiatives, which are shared with the rest of the European banking sector. The authorities look forward to the upcoming 2017 FSAP, which will be concluded by next September.
Private sector deleveraging
The deleveraging process of the private sector has been particularly intensive; non-consolidated private sector debt has fallen by 50 percentage points since 2010, almost converging with the euro area average in the third quarter of 2016. Corporate indebtedness has fallen below the euro area average and household debt has decreased by almost 20 p.p., standing slightly above the euro area level. More importantly, this deleveraging process has been compatible with new loans to SMEs and households. As the IMF correctly states, “the stronger banking system has been broadly supportive of the economic recovery, with financial conditions having eased further.”
Fiscal consolidation has played an important role in restoring confidence. Over the last years Spain has delivered one of the largest fiscal adjustments in the Eurozone, against the backdrop of a severe recession. According to IMF projections, public deficit will stand at 4.5 percent of GDP in 2016 and 3.2 percent in 2017, broadly in line with the authorities’ views. With the support of other political parties, the government has approved fiscal measures amounting to more than €7 billion for 2017, including, among others, increases in the CIT tax base, increases in excise taxes and improvements in tax collection. The European Commission estimates that these measures will yield an adjusted fiscal structural effort of 0.7 percent of GDP, thus continuing with the consolidation process initiated a few years ago. With all these measures, included in the updated Draft Budgetary Plan of Spain, the European Commission considers that Spain is broadly compliant with the provisions of the Stability and Growth Pact. The negotiation of a new budget for 2017 is now under way, and the government is committed to deliver the fiscal targets for 2017. Unlike the IMF, we do not foresee any need to raise VAT in the future, as the implementation of the spending rule should be sufficient to bring down the deficit to equilibrium in structural terms going forward.
The public debt to GDP ratio peaked in 2014 and both the IMF and the authorities expect it to come down to around 99 percent of GDP in 2017 and decline further in the coming years. The debt reduction strategy is based on an adequate fiscal consolidation path and the government’s full commitment to comply with the objectives of the Stability and Growth Pact.
We concur with staff on the need to raise productivity, particularly for SMEs, through structural reforms. The authorities are committed to guaranteeing continuous implementation of the Market Unity Law, curbing red tape and market fragmentation, improving SMEs’ financing, corporate governance and competition. Similarly, there is consensus on the need to support SME growth, which should help to foster R&D investment and the export capacity of companies. The authorities are very appreciative of the analytical work made by staff regarding competitiveness, productivity and the impact on growth of structural reforms, which is estimated to be 2.5 p.p. in the next five years.
Economic policy and priorities
Going forward, the strong recovery of the Spanish economy does not imply that risks or challenges have disappeared. In fact, as the staff report points out, external risks have not abated and there are stock imbalances, such as high unemployment and high public debt, which take time to be fully addressed and therefore deserve full attention by the authorities.
On this issue, we understand staff’s concerns that political fragmentation could pose challenges to rekindling momentum for structural reforms and fiscal consolidation. However, the significant number of reforms and measures announced by the new Government and the main political partners since last December point to a reformist agenda. Some of these measures have not been included in the staff report due to the cut-off date, and they are relevant in structural terms.
Aside from the fiscal measures already mentioned, the recent Draft Budgetary Plan includes plans to mandate the independent fiscal authority to conduct a thorough expenditure review at all levels of the administration. An expert committee on pension reform will be set up and Parliament will debate its main findings in the coming months. Similarly, a high level working group on regional financing will be established with a view to a new regional financial framework within one year. In the financial sector, a Royal Decree Law has been recently adopted by the Council of Ministers establishing a new out-of-court procedure to facilitate a smooth resolution of claims related with non-transparent floor clauses. Moreover, the Government has announced reforms to the current Law on Mortgages which will improve consumer protection.
After months of political uncertainty, a new government is finally in place. The impressive achievements of the Spanish economy in the last few years, as highlighted by the staff report, are the result of an ambitious structural reform program coupled with fiscal consolidation, which have allowed the economy to reap the full benefits of tailwinds, regaining the competitiveness lost, largely correcting its macroeconomic imbalances and fostering confidence in the future.