III Economic Policy Setting
Author: International Monetary Fund
Language:
English
Keywords:
OP; policy; rate; oil price rise; Spain; U.S. dollar; consumer price index; fiscal policy; merchandise export; term capital; Public sector; Imports; Monetary expansion
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Abstract

The authorities entered 1983 determined to bring inflationary expectations under control and to redress the external imbalances. In a year largely viewed as one of transition during which the groundwork was to be laid for future stabilization measures and structural reforms, the authorities adopted an economic program that projected some recovery of output growth to about 2 percent, a deceleration in the rate of inflation to 12 percent by the end of the year, and a reduction of the current account deficit from 2.3 percent of GDP in 1982 to 1.5 percent (Table 2). Policy measures intended to support the attainment of these objectives included a reduction in the targeted rate of growth of M3 by 2½ percentage points to 13 percent, a broad stabilization of the fiscal deficit in relation to GDP at 1982 levels, and a substantial moderation of wages. To restore Spain’s external competitiveness the peseta was devalued by 8 percent against the U.S. dollar in early December 1982 and was allowed to depreciate further throughout 1983. By the fourth quarter of 1983 the peseta had depreciated by 11½ percent in real effective terms with respect to the same quarter in 1982 (Table 3 and Chart 1).

The authorities entered 1983 determined to bring inflationary expectations under control and to redress the external imbalances. In a year largely viewed as one of transition during which the groundwork was to be laid for future stabilization measures and structural reforms, the authorities adopted an economic program that projected some recovery of output growth to about 2 percent, a deceleration in the rate of inflation to 12 percent by the end of the year, and a reduction of the current account deficit from 2.3 percent of GDP in 1982 to 1.5 percent (Table 2). Policy measures intended to support the attainment of these objectives included a reduction in the targeted rate of growth of M3 by 2½ percentage points to 13 percent, a broad stabilization of the fiscal deficit in relation to GDP at 1982 levels, and a substantial moderation of wages. To restore Spain’s external competitiveness the peseta was devalued by 8 percent against the U.S. dollar in early December 1982 and was allowed to depreciate further throughout 1983. By the fourth quarter of 1983 the peseta had depreciated by 11½ percent in real effective terms with respect to the same quarter in 1982 (Table 3 and Chart 1).

Table 2.

Spain: Selected Economic and Financial Indicators, 1982–87

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Sources: Bank of Spain, Ministry of Economics and Finance; and Fund staff estimates.

Provisional.

Staff estimates.

Contribution of GDP growth.

End of period.

End of October 1987.

Average for January—November.

Average change over January-November.

Upper limit of a target band centered at 8 percent; 12-month rate of growth for September was 13.9 percent.

By the credit system and the money markets.

Twelve-month rate of growth for September.

Table 3.

Spain: Exchange Rate Developments, 1978–87

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Sources: International Monetary Fund, International Financial Statistics, various issues; Fund staff estimates; and Bank of Spain.

Period average.

Trade weighted average of exchange rates expressed as units of foreign currency per peseta. A decline in the index indicates a depreciation. The weights are based on the distribution of export and import trade with 19 partner countries during 1980–82.

Index of the trade weighted average ratio of Spain’s consumer price index to the consumer price indices of partner countries multiplied by the nominal effective exchange rate. The weights are the same as in footnote 2, and a decline in the index also indicates a depreciation.

Vis-à-vis the currencies of the member countries of the EC, as calculated by the Bank of Spain.

Chart 1.
Chart 1.

Spain: Indices of Exchange Rates, 1980–86

Source: International Monetary Fund, International Financial Statistics, various issues; and Research Department. Fund staff calculations.1Vis-à-vis 19 partner countries.2Relative consumer prices corrected for exhcange rate changes.

Two clearly defined sub-periods can be identified over the adjustment process. The first, covering 1983–84, was characterized by a nonaccommodating stance of policies and a concomitant recovery of output, a major turnaround in the current account of the balance of payments, and a significant deceleration in the rate of growth of prices and costs. The second, over 1985–86, witnessed a relaxation of the policy stance as a result of the continued improvement in the external accounts and in order to facilitate a more balanced composition of growth, particularly a recovery of investment.

Monetary Policy

Overview

Monetary policy has played a crucial role in the adjustment program implemented by the authorities over the period 1982–86. In late 1982, against a background of accelerating inflation, growing fiscal imbalances, and a rapid deterioration of the external accounts, the authorities significantly tightened the stance of monetary policy. The rate of growth of liquid assets in the hands of the public (ALP) decelerated markedly, short-term interest rates rose sharply, and credit extended to the private sector slowed down. This nonaccommodating stance was instrumental in bringing about a significant deceleration in prices and costs. The rate of inflation fell from 14.4 percent on average in 1982 to 9 percent by the end of 1984, while the rate of growth of nominal wages fell from 14 percent to 10 percent over the same period. In conjunction with an improvement in the external environment, particularly during 1984, when the rate of growth of the volume of non-oil imports in Spain’s partner countries rose by over 8 percent, it contributed to a rapid turnaround in the external accounts. By late 1984, however, as the domestic recession deepened (domestic demand fell in real terms that year), the authorities moved toward an easier stance of monetary policy. The need to promote a recovery of investment, which had fallen by over 11 percent in real terms over the 1981–83 period, from 21½ to 20 percent of GDP, and some concern about the increasing burden on the budget of servicing the public debt10 prompted the authorities to permit a somewhat faster rate of growth of total liquidity and a concomitant fall in interest rates.

The stance of monetary policy over 1985–86 can also be characterized as broadly accommodating. Liquidity growth decelerated less rapidly than in the previous two-year period, interest rates both in real and nominal terms were, on average, lower than during 1983–84, and domestic credit to the private sector recovered significantly. This easier stance contributed to the recovery of domestic demand, which grew by 2½ percent in 1985 and by over 6 percent in 1986, and in particular that of fixed investment, which expanded by a cumulative 15.1 percent in real terms over the same period. Efforts to reduce further the inflation differential vis-à-vis Spain’s main trade partners were less successful, however, as the rate of inflation in 1986 remained unchanged with respect to 1985 at 8.8 percent. An important contributing factor behind this development was the introduction of the value-added tax in early 1986 as part of Spain’s accession to the EC, which added about 2 percentage points to the consumer price index and thus prevented a further deceleration of the rate of inflation.

Implementation

The monetary authorities’ efforts to restore a stable financial environment after the crisis years 1980–82 have been centered around one basic strategy: a gradual deceleration of the monetary aggregates according to preannounced quantitative targets. The announcement of such quantitative targets for the money supply was thought to be a key element in the authorities’ efforts to shape expectations. The setting of such targets in a medium-term context, involving a progressive deceleration of monetary growth, was seen as the basis for engineering an effective break in inflationary expectations (Chart 2). The monetary growth targets have been given as a band with a width of ± 1.5–2 percentage points, with the implicit understanding that the aim was the mid-point of the range.11 Although for 1983 the targeted growth rate for M3 was set at 13 percent (± 2 percent; against a projected growth of nominal GDP of about 14 percent) the Bank of Spain also set a target of 16 percent for the growth of the broader aggregate ALP.12 The rapid development of a market for treasury bills held by the nonfinancial public and other nonmonetary liabilities that were close substitutes for money had begun to reduce the reliability of M3 as an indicator of total liquidity. In subsequent years this shift in emphasis from M3 to ALP was made formal, and the monetary targets were set with reference to the latter aggregate.

Chart 2.
Chart 2.

Spain: Total Liquidity (ALP), Target Band and Outturn, 1985–861

In billions of pesetas

Source: Bank of Spain.1Monthly averages of daily data, seasonally adjusted.

The growing borrowing needs of the public sector and the creation of liquid assets not included in broad money made monetary control in 1983 especially difficult. Because the monetary aggregates were growing in the early part of the year at rates well above the upper limits of their targeted ranges, the monetary authorities began a gradual tightening of monetary policy. Reserve requirements were raised in April and August, while increasing amounts of Certificates of Monetary Regulation (CMR)—a central bank liability used in open market operations—were sold to the banking system. Moreover, moral suasion was used to discourage the banks from stepping up the creation of alternative liquid assets not included in the definition of money, such as bankers’ acceptances and various types of bonds (Bonos de Caja y Tesoreria). As a result of these measures, interest rates rose to historically high levels (Chart 3); by the third quarter of 1983 the three-month interbank rate had risen by 6 percentage points to 23 percent, while the rate paid on treasury bills stood at 16 percent, well above the 11 percent rate of inflation. Against a background of rapidly rising interest rates and in order to lower the interest costs associated with the need to finance the budget deficit, which had been largely supported by Bank of Spain financing out of its capital accounts, the cash and mandatory deposit coefficients were replaced by a new, broader cash coefficient. The CMRs were phased out and replaced by a special issue of treasury bills for which a special coefficient was created. These new coefficients added up to 30 percent of the banking system’s liabilities, an effective increase of 7 percentage points over the previous system. Notwithstanding the difficulties experienced by the authorities in the instrumentation of monetary policy during 1983, its overall objectives were attained. ALP rose by 15.7 percent, slightly below the mid-point of the target range (Table 4).13 The rate of growth of consumer prices fell to 12.2 percent while output grew by 2 percent. More significantly, the deficit on the current account of the balance of payments was reduced by nearly US$1.5 billion—from 2.3 to 1.7 percent of GDP. Although the rate of growth of domestic credit was on target, its composition was not, with credit to the public sector rising by over 40 percent against an expansion of credit to the private sector of less than 10 percent.

Chart 3.
Chart 3.

Spain: Selected Interest Rates, 1982 (IV)–1987 (III)

In percent

Source: Bank of Spain.1Three month.2One to three years.3One to two years.4Measured by the year-on-year percent change in the consumer price index.
Table 4.

Spain: Monetary Survey, 1982–86

(In billions of pesetas; end of period stocks)

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Source: Bank of Spain, Statistical Bulletin.

Includes the public enterprises and the private sector.

Monthly average of daily data; this is the aggregate actually used by the authorities for the purpose of monetary control.

The evolution of the monetary aggregates during 1984 can be seen as the continuation of the process of deceleration begun in early 1983. Although ALP did not decelerate as rapidly as anticipated in the initial monetary program—a target of 12.5 percent with a lower limit of 10.5 percent and an upper limit of 14.5 percent—this can largely be interpreted in terms of the higher-than-projected public sector borrowing requirement and the unexpectedly large inflows of liquidity through the balance of payments. Foreign exchange reserves increased by over US$4.5 billion, in sharp contrast to the initial program’s projection of no change. ALP grew by 14.2 percent or near the upper limit of its target range. Although overall domestic credit expansion was within target, its composition, as in 1983, differed from initial projections. Low private sector demand for bank credit, associated with the domestic recession, appears to have been the overriding factor behind the 6 percentage point shortfall in private sector credit expansion with respect to the original target.

For 1985, the authorities sought a mix of monetary and exchange rate policies that would contribute to a more balanced growth than in 1984, a year in which domestic demand had made a negative contribution to GDP growth. The revival of domestic demand was to come about through an increase in real incomes stemming from lower price increases and reduced inflationary expectations. With this overall objective in mind the rate of growth of ALP was targeted at 13 percent with a ± 1.5 percent band of fluctuation. Although this implied a reduction of only 1.2 percentage points with respect to the 1984 outturn, it was consistent, in light of the declining trend in velocity registered in recent years, with real GDP growth of around 3 percent and a further deceleration in the rate of inflation to 7–8 percent. This rate of monetary expansion was also judged to permit a recovery of credit to the private sector, which, however, would still remain negative in real terms; such recovery assumed a marked deceleration in the rate of growth of credit to the general Government from the over 40 percent registered in 1984 to a target of 25 percent in 1985. On the external front, the monetary authorities decided to counteract the heavy inflow of reserves through the balance of payments with some liberalization in the rules governing Spanish investments abroad and the anticipated amortization of external debt, policies that were expected to halt the peseta’s appreciating trend seen throughout the previous year.

In the event, ALP grew in 1985 by 13.2 percent. Given GDP growth of 2 percent—wholly led by domestic demand—this implied a drop in velocity of the order of 2 percent. Credit to the private sector rose by close to 7½ percent, while the claims on the general Government by the financial system rose by 34 percent, well above target. Nominal interest rates continued their downward trend, and at the end of 1985 real rates were an average of 3 percentage points below the high levels reached in the middle of the year.

Monetary policy for 1986 was framed in an environment fraught with uncertainty. New legislation on the taxation of financial assets, which exempted treasury bills from an 18 percent withholding tax applied to all other short-term assets, made it difficult to forecast the evolution of the demand for money. In the first half of the year a substantial amount of paper issued by various financial institutions was scheduled to come due, and, given the exclusive tax treatment granted to treasury bills, further asset substitution was likely.14 The extent of this substitution (and thus the changes in the composition of ALP) would depend on the stance taken by the Treasury as regards interest rates. The demand for ALP would partly depend on the resulting mix between fiscal advantage and profitability accorded to treasury bills. Furthermore, the scheduled introduction of the VAT in early 1986 was also expected to have an adverse impact on consumer prices. With these imponderables in sight, the monetary authorities established a tentative band for ALP growth in 1986 centered on 11 percent with a margin of ± 1.5 percent. This rate of expansion was seen to be consistent with real GDP growth in the neighborhood of 2–2½ percent and an 8 percent rate of inflation and to permit growth of credit in the order of 21 percent to the public sector and of 7½ percent to the private sector.

The drastic changes in the international economic environment that characterized 1986—large drops in the price of oil, the continued depreciation of the U.S. dollar, and declining interest rates—did not dissipate these uncertainties. Some deceleration in the rate of growth of ALP did take place; the 12-month rate for December stood at 11.3 percent, or nearly 2 percentage points below the corresponding figure for the end of 1985. M3, which had decelerated rapidly throughout 1985, continued to do so during 1986 with December levels only 3.9 percent above the corresponding levels for December 1985. Most of this deceleration could be attributed to a reduction of time deposits in favor of treasury bills and bank’s nonmonetary liabilities, both included in ALP. The authorities accommodated the stimulus to demand engendered by the gain in the terms of trade induced by the lower price for oil. GDP grew by 3.3 percent in 1986, exclusively under the impetus of domestic demand, which rose by 6.3 percentage points.

There can be little doubt that monetary policy made an effective contribution over the initial two-year period to the authorities’ anti-inflation objectives. Against the background of rapid monetary expansion in the early 1980s, the associated failure to secure greater price stability and the rapid deterioration of the fiscal accounts, all factors that had eroded the public’s confidence in the Government’s commitment to reduce inflation and that had been largely responsible for the emergence of large deficits in the current account of the balance of payments, the devaluation of December 1982 and the substantial tightening of money throughout 1983–84 must be seen as key ingredients of the stabilization effort. The conduct of monetary policy over this period may have alleviated the uncertainties generated by the arrival of a Government with a different political orientation and social agenda and no doubt contributed to the deceleration of inflation and nominal wages.

Fiscal Policy

Overview

The financial position of the general Government deteriorated steadily after 1975 as the deficit on a national accounts basis (excluding net lending) rose from an average of 1.1 percent over the period 1976–79 to 5.6 percent of GDP in 1982. This deterioration was the result of expenditure growth associated with a rapidly expanding public sector (public consumption grew at an average annual rate of about 4½ percent in real terms between 1975 and 1982), improvements in the level and coverage of social security benefits without commensurate increases in contributions, increasing transfers of financial resources to ailing enterprises, and a domestic recession.

It is useful, in making an assessment of recent government policy vis-à-vis the public sector, to distinguish three broad and interrelated areas of fiscal endeavor. Fiscal policy may be examined in terms of its impact on the financial position of the government, the role of the public sector in the provision of goods and services, and the government’s regulatory role within the various sectors of the economy. In each of these areas there have been attempts—some quite successful—to introduce structural reforms aimed at enhancing efficiency.15 Against a historical background of substantial government involvement in economic activity, which had often led to undue regulation and overprotection, and in light of the rising fiscal imbalances that characterized the early 1980s, the process of reform has not been an easy one. Several decades of an interventionist approach to economic policy had given rise to important rigidities whose elimination, in the authorities’ view, was to be accomplished gradually.

Over the four-year period of adjustment under review, a number of measures were implemented with important allocational implications for the medium term. The introduction of the value-added tax in early 1986 in the framework of EC accession widened the tax base and substituted for a number of inefficient indirect taxes. A much needed and politically difficult reform of the pension system took place in 1985, whose aims—a deceleration in the rate of growth of beneficiaries and an increase in the level of contributions—began to become evident in 1986. With respect to the public sector’s provision of goods and services the trend has been toward a gradual retrenchment in those areas where government presence was not seen as necessary for the accomplishment of specific social objectives (e.g., the alleviation of unemployment in certain regions of the country). Privatization and industrial restructuring have therefore been at the center of the government’s retrenchment strategy, which has already improved the financial position of public enterprises. Nevertheless, measured in terms of the magnitude of the public sector deficit, progress in improving public finances has been relatively modest, with the deficit remaining at over 5 percent of GDP throughout most of the adjustment period.

Implementation

From the outset of the reforms the authorities recognized the importance of improving public sector finances. The objective for 1983 of halting their deterioration was overshot, and the deficit on a national accounts basis (excluding net lending) was reduced to 4.8 percent of GDP (Table 5). This outcome was achieved mainly through an increase in the tax burden resulting from increases in the rates of indirect taxation and a modification of the schedule of withholdings for the personal income tax, together with some reduction in exemptions. The combined effect of these tax changes resulted in a substantial increase in tax revenues from 14.6 percent of GDP in 1982 to 16.4 percent in 1983. This improved revenue effort was, however, partly offset by a continued rise in public expenditure, particularly an accelerated increase in pension payments, unemployment compensation expenditures associated with the deterioration of labor market conditions, and a rise both in transfers to enterprises and in the general government wage bill. Current expenditures continued to rise rapidly in 1984, reaching the equivalent of 34 percent of GDP, a 1 percentage point increase with respect to the 1983 outturn. Moreover, there were marked changes with respect to the previous year in the behavior of its individual components. Interest payments on the public debt rose by more than 75 percent owing to the rapidly rising stock of debt and the more explicit accounting of interest charges in the budget stemming from the growth of financing through treasury bills. Social security benefits, which had grown by 15.1 percent in 1983, grew by 11.6 percent in 1984, but actually fell in relation to GDP from 15.1 percent to 14.4 percent on account of a deceleration in the rates of growth of the number of pensioners and of the average monthly pension. A significant deceleration in the rate of growth of current revenue (particularly social security contributions, which also fell in relation to GDP) in association with the domestic recession contributed to the emergence of a budget deficit in 1984 of the order of 5½ percent of GDP.

Table 5.

Spain: General Government Operations, 1982–87

(National accounts basis; in percent of GDP)

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Sources: Data provided by the Spanish authorities; and Fund staff estimates.

Provisional.

Preliminary official estimates.

In 1985 the public finances deteriorated as the non-financial deficit rose to the equivalent of 6.7 percent of GDP. Although the 1985 budget had not contemplated any changes in tax legislation, the authorities introduced in May a number of modifications in the withholdings schedule of the personal income tax in an attempt to stimulate private consumption, which had fallen in real terms in 1984 and had shown no obvious sign of recovery in the first months of 1985. These changes contributed to a deceleration in the rate of growth of taxes on income and property, from 19.3 percent in 1984 to 13.8 percent in 1985.

Indirect taxes continued to grow at rates well above those of nominal GDP, expanding in 1985 by 20 percent. This relatively high rate of growth of indirect taxes stemmed from both buoyant revenues on account of the turnover tax, whose coverage was extended throughout the year as a preparatory step in anticipation of the introduction of the value-added tax, and a recovery of import taxes associated with a 7 percent expansion in the volume of merchandise imports. The rise in the tax burden in 1985 was to a great extent accounted for by the more rapid growth of indirect taxes. Social security contributions on the other hand grew, as in previous years, at rates well below those corresponding to tax revenues. This performance is largely the result of fiscal policies that have attempted to reduce the costs to the employer of social security contributions with a view to stimulating employment, particularly for new entrants into the labor force.

Perhaps the most salient feature of the public sector’s operations in 1985 concerns the rapid increase in the share of current expenditure allocated to interest payments on the public debt. This share rose from 1.2 percent of GDP in 1983 to 3.5 percent of GDP in 1985 as the stock of net public debt rose, over the same period, from 18.1 to 27.5 percent of GDP. This marked increase was partly linked to the changes introduced by the authorities in 1983–84 in financing the deficit, which attempted to shift some of its burden from central bank profits to the budget and thus make its costs more explicit. Central bank financing had led to the rapid growth of the monetary base; to prevent over-shooting the targets for the monetary aggregates, the Bank of Spain had resorted to sterilization through the sale to the banking system of securities (Certificates of Monetary Regulation) and to a concomitant tightening of reserve requirements. The high reserve and investment ratios associated with this process had contributed to the substantial spread between lending and deposit rates, as financial institutions attempted to preserve profitability through relatively high lending rates on that portion of their assets not subject to reserve requirement and through relatively low rates on deposits.16

This interest rate wedge has well-known adverse allocational repercussions. It introduces distortionary effects on savings and investment and thus represents a form of taxation of the economy’s productive sectors.17 In the case of financing through issues of government paper, such as the treasury bills introduced in 1983, the costs of the deficit are absorbed by the budget, leading to an increase in the share of current expenditure allocated to interest payments. Financing of this type need not in itself be a particularly severe constraint in the conduct of fiscal policy if the deficits are “small” or declining with respect to GDP. Furthermore, it has none of the negative impact that central bank financing has on the allocation of financial resources. The persistence of growing public sector deficits over time may, however, give rise to a situation in which, even within a relatively short span of time (three years in Spain), there is a rapid growth in the interest component of public expenditure leading, in the absence of concomitant cuts in other items of expenditure, to higher deficits and the need for further financing in what can correctly be characterized as a potentially destabilizing situation.18 The steep rise in the interest burden of the public debt over so short a time underscores the constraints that inevitably begin to emerge for the conduct of financial policies as a result of repeated large public sector deficits. The extent to which the need to finance such deficits strongly influences the fiscal outcome in later periods is made clear by the fact that, net of interest payments, the general Government deficit excluding financial operations actually fell in 1985 with respect to 1984. This would suggest that to the extent that servicing the public debt reflects past fiscal performance, the eventual reduction of the general Government deficit will largely depend on the authorities’ determination to reduce noninterest expenditure.19

The year 1986 witnessed a return to the trend initiated in 1983 of lower public sector deficits and reduced borrowing requirements. The nonfinancial deficit was reduced to 5.7 percent of GDP. Possibly the most noteworthy fiscal development in 1986 was the successful introduction of the value-added tax. Although it added about 2 percentage points to the consumer price index, it permitted a substantial expansion of the taxable base. In conjunction with the increased taxation of petroleum products—domestic oil prices were only partly adjusted to reflect the sharply lower import prices—the introduction of the VAT led to a 30½ percent rise in indirect tax revenues, which more than compensated for the revenue losses associated with the stimulative measures approved in mid-1985, whose full year impact in 1986 is estimated at about 0.6 percent of GDP. There is ample evidence that the buoyancy of tax receipts during 1986, and also in 1987, is at least partially attributable to genuine improvements in tax collection and administration.20 In 1986 alone there was a rise of 8 percent in the number of individuals filing tax returns (equivalent to half a million contributors) and a marked increase in the average income declared by individual entrepreneurs. The resumption of the trend toward greater fiscal restraint seen during 1986 appears to have strenghthened in the course of 1987. The strong expansion of economic activity throughout 1987, with real GDP growth close to 4.5 percent, resulted in tax receipts much higher than anticipated in the budget. The general Government nonfinancial deficit (on a national accounts basis and excluding net lending operations) is estimated to have fallen to 3.6 percent of GDP, a reduction of 2 percentage points of GDP with respect to the 1986 outurn.

External Policies

The peseta has been managed flexibly for a number of years, with the Bank of Spain intervening in the foreign exchange markets to prevent undesirable fluctuations and to ensure the maintenance of competitiveness for Spanish exports. Other factors, such as the impact of exchange rate changes on domestic prices, on servicing external debt, and on the rate of accumulation of international reserves, have also influenced the timing and extent of the Bank’s interventions. Two major trends can be identified in the evolution of the exchange rate in recent years (Chart 1). Following the 8 percent devaluation of the peseta in December 1982, the various indicators used to measure external competitiveness improved remarkably. The peseta depreciated in 1983 by 23 percent on average against the U.S. dollar and 19½ percent against the deutsche mark; on a trade-weighted basis the nominal effective depreciation exceeded 15 percent, while the real effective rate, expressed in terms of relative consumer prices, recorded a gain in competitiveness in excess of 12 percent with respect to 1982 (Table 3). While the peseta continued to lose ground against the dollar throughout 1984 and the first quarter of 1985, reflecting the marked appreciation of the dollar in the international exchange markets, it began to appreciate against the currencies of its main European trade partners. This resulted in a real effective appreciation during 1984 of the order of 3 percent, thus partly eroding some of the competitive gains that had occurred in 1983 and had led, in conjunction with a substantial expansion of foreign demand, to a 17 percent rise in the volume of exports, the highest rate of growth over the previous decade (Table 6).

Table 6.

Spain: Terms of Trade, Volume and Price Indices, 1978–871

(1980 = 100; prices in pesetas)

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Source: Ministry of Economy and Finance, Sintesis Mensual de Indicadores Economicos, December 1987.

Based on customs data.

For total exports and imports.

Preliminary.

The weakening of the dollar in the second half of 1985 did not lead to a deterioration in overall competitiveness because the peseta depreciated against the currencies of the major European countries, which account for over 50 percent of Spanish trade. The Bank’s intervention policy during 1986 attempted to maintain the real value of the peseta vis-à-vis the European Currency Unit (ECU) at the average level of 1985. The broad achievement of this target did not prevent a renewed appreciation of the real effective rate. Largely in an effort to mitigate the effects of the rapid accumulation of international reserves, which could have endangered the achievement of monetary policy objectives, the authorities let the peseta appreciate by 8.8 percent in real effective terms in the 12-month period ending December 1986. This put the index at a level not substantially different from that prevailing prior to the 1982 devaluation.

The picture of competitiveness that emerges from the recent evolution of unit labor costs in the manufacturing sector is not radically different. The ratios of Spain’s index of unit labor costs in the manufacturing sector to a weighted average of the corresponding indices for 16 industrial countries and for the EC, adjusted for changes in the nominal effective exchange rate, are presented in Table 7. The table also presents the results of such comparison vis-à-vis a number of partners or competitors. In all cases, there was a marked improvement in the relative competitive position of Spain in 1983, followed by some erosion of these gains in 1984, and little further change during 1985 and 1986. While the ratios for 1986 as a whole still compare favorably with 1982, the comparison vis-à-vis the set of 16 industrial countries during 1986 is somewhat less favorable on account of the appreciation of the peseta mentioned above.

Table 7.

Spain: Competitiveness in Manufacturing, 1980–87

(1980 = 100)

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Sources: Bank of Spain; and Fund staff calculations.

Staff forecasts.

Ratio of Spain’s unit labor cost index in the manufacturing sector over the index of comparator country, adjusted for changes in the exchange rate between the currencies of the two countries.

Ratio of Spain’s unit labor cost index in the manufacturing sector over a weighted average of unit labor cost indices of eight member countries of the European Community adjusted for changes in the nominal effective exchange rate.

Ratio of Spain’s unit labor cost index in the manufacturing sector over a weighted average of unit labor cost indices of 16 industrial countries adjusted for changes in the nominal effective exchange rate. The weights are based on the distribution of Spain’s exports and imports during 1980–82.

The relatively active exchange rate policy over the initial phase of the adjustment process (1983–84), followed by the broad stabilization of the real exchange rate vis-à-vis the ECU, has played a crucial role in the restoration of Spain’s external accounts. Much of this improvement can be attributed to the strong growth of the export sector which, over 1981–84, grew at an annual average rate of 9¾ percent in real terms (Chart 4). Table 8 shows the rates of growth of merchandise exports over the previous six-year period and the evolution over time of a number of variables that are thought to have had an important influence on export performance. The information presented in Table 8 permits a qualitative assessment of the impact of such variables as the real effective exchange rate and the evolution of domestic and foreign demand and thus sheds some light on the reasons for the marked turnaround in the external accounts referred to above. (See Appendix II for further discussion of this issue.)

Chart 4.
Chart 4.

Spain: Trade Developments, 1978–86

(1978 = 100)

Source: National Institute of Statistics; and International Monetary Fund, staff calculations, Research Department.
Table 8.

Spain: Determinants of Export Performance, 1980–86

(Annual percentage change)

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Source: Fund staff calculations.

Vis-ä-vis 19 partner countries and lagged one period; a negative sign indicates a depreciation of the peseta.

Changes in the competitiveness of the peseta have been a key factor in the turnaround. Allowing for a one-year lag in the impact of exchange rate changes on trade flows, Table 8 shows a close correspondence between real effective depreciations and export growth. The relatively poor performance of exports in 1980, despite a large rise in the volume of non-oil imports among Spain’s partner countries, followed a real appreciation in the previous period in excess of 16 percent. The substantial improvement in the following years—exports expanded in real terms by a cumulative 45 percent between 1981 and 1984–coincided with a real depreciation of the peseta in excess of 20 percent. This relationship appears to be particularly strong in 1984 when exports grew by 17 percent, following a 12¼ percent real depreciation of the peseta in the previous year.

Export performance also appears to be linked to domestic demand developments. The Spanish authorities claim that the relative weakness of domestic demand has frequently spurred export growth. The inverse association between these two variables is clearly borne out by the data over the 1980–86 period. After three years of virtually no growth, domestic demand recovered in 1980 and grew by slightly over 2 percent even as the rate of growth of exports fell from an annual average of 10.6 percent over 1977–79 to –0.1 percent. Over the next four years Spain experienced its deepest recession in recent history, with domestic demand falling in real terms in 1981 for the first time in more than 20 years. Although there was a recovery in 1982, further contraction over 1983–84 brought the cumulative drop in domestic demand over the period to nearly 2 percentage points. This same period witnessed a sustained expansion of exports and some of the largest gains in market shares over the previous decade. The recovery of domestic demand in the second half of 1985 and throughout 1986 appears to have contributed, in conjunction with other factors, to a substantial contraction of exports. Although there was a marked improvement in tourist activity, merchandise exports actually fell by over 4 percent in real terms in 1986.21

The turnaround in Spain’s external accounts would not have been as rapid had it not been for the sluggishness of imports. During 1981–84, imports of goods and services fell by a cumulative 2 percent in real terms, reflecting the slackness of domestic demand. Imports recovered in 1985–86, growing by well over 20 percent in volume, but, as mentioned above, the role of domestic demand had changed radically with respect to the prior four-year period and other factors, such as a decline in interest rates and gains in the terms of trade, came to play a relatively more important role in the determination of the current account surplus (Chart 5).

Chart 5.
Chart 5.

Spain: Trade Prices and Terms of Trade, 1978–86

(Percentage change over previous period)

Source: National Institute of Statistics and Ministry of Economy and Finance.1Based on customs data, in pesetas.

A number of policy measures were implemented during 1985–86 in the area of external liberalization. The substantial relaxation of the rules governing foreign direct investments introduced in mid-1985 was followed in late 1986 by a corresponding liberalization of investments abroad undertaken by Spanish residents. As part of Spain’s accession to the EC, tariffs on industrial imports from EC countries were sharply reduced (and are to be phased out by 1992) while those on imports from non-EC countries also began a process of reduction intended to bring them down to the EC’s Common External Tariff (CET) within the same time frame. Nontariff trade barriers and quantitative restrictions were likewise largely eliminated. At the same time, the additional protection traditionally given to Spanish industry through an export subsidy scheme was eliminated as part of the overhaul of the system of indirect taxation implied by the introduction of the VAT. A detailed discussion of these liberalization measures is provided in Section IV.

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Cover Search for Efficiency in the Adjustment Process
Search for Efficiency in the Adjustment Process
Spain in the 1980's; Op 57
Author: International Monetary Fund
ISBN:
9781557750099
ISSN:
0251-6365
Publication Date:
26 Feb 1988
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557750099.084
Pages:
56
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    Spain: Indices of Exchange Rates, 1980–86

  • View in gallery

    Spain: Total Liquidity (ALP), Target Band and Outturn, 1985–861

    In billions of pesetas

  • View in gallery

    Spain: Selected Interest Rates, 1982 (IV)–1987 (III)

    In percent

  • View in gallery

    Spain: Trade Developments, 1978–86

    (1978 = 100)

  • View in gallery

    Spain: Trade Prices and Terms of Trade, 1978–86

    (Percentage change over previous period)

Spain: Indices of Exchange Rates, 1980–86

Spain: Total Liquidity (ALP), Target Band and Outturn, 1985–861

In billions of pesetas

Spain: Selected Interest Rates, 1982 (IV)–1987 (III)

In percent

Spain: Trade Developments, 1978–86

(1978 = 100)

Spain: Trade Prices and Terms of Trade, 1978–86

(Percentage change over previous period)