1. This supplement reports on information on economic and financial developments in Spain since the issuance of the staff report for the 2000 Article IV consultation (SM/00/222, 9/29/00) to the Executive Board. The information does not alter the thrust of the staff appraisal.

2. Consumer price inflation in September rose to 3.7 percent (on a 12-month basis), slightly above the 3.6 percent increase recorded in July and August. Underlying inflation (which excludes energy and unprocessed foodstuffs) held constant at 2.7 percent in September. Producer price inflation declined to 5.1 percent in August (on a 12-month basis), down from 5.5 percent in July. The current account deficit through July equaled 2.8 percent of GDP, versus 2.7 percent through June.

3. On October 5, the ECB increased its main refinancing rate by 25 basis points to 4.75 percent. Given the continued weakness of the euro, and the uptick in consumer price inflation which diminishes the real impact of the nominal rate increase, it remains the staffs view that monetary conditions in Spain are more accommodative than might be appropriate from a purely Spanish perspective.

4. Some recent indicators support the Staff Report’s projection that domestic demand growth would continue to slow over the course of 2000–01. The index of consumer confidence dropped sharply in September, to its lowest level in two years, while registrations of new automobiles fell by 20 percent compared to the same month a year earlier. The index of confidence in the retail sector also declined in September, following a very steep drop in July. In addition, the Ministry of Economy’s synthetic indicators of private consumption and goods investment portend slower growth in the third quarter. These declines likely reflect in large part uncertainty arising from very high oil prices.

5. The staff has revised its macroeconomic projections based on updated country information, a revised interest rate path reflecting recent market expectations, and a new baseline for oil prices (some US$5 per barrel about the baseline in the published WEO, with an average price of US$29 per barrel for 2000). The revised assumptions have no effect on projected output growth or inflation in 2000. However, real GDP is now projected to grow by 3.2 percent in 2001, compared to 3.5 percent in SM/00/222, while headline inflation is forecasted at 2.7 percent, compared to an estimate of 2.4 percent in the staff report. These changes are in line with those produced for other euro area countries, leaving growth and inflation differentials relative to the euro-area averages essentially unchanged in 2001, relative to the estimates in SM/00/222.

6. Importantly, the revised projections assume that higher oil prices and headline inflation do not lead to a significant loss of wage moderation, and the effects could be considerably greater were this commitment to wane. This emphasizes the need for continued progress in labor market reform, to allow for further reductions in the structural unemployment rate to help forestall the emergence of wage pressures. Data on collective bargaining agreements through September show no indication of an acceleration of wage growth, but the fact that many labor contracts include “safeguard clauses” to compensate workers when inflation exceeds the official forecast means that some of this year’s higher-than-expected inflation will spill over into wage growth next year.

7. The authorities have indicated that they expect to overperform somewhat on the revised fiscal deficit target of 0.4 percent of GDP for this year, although they have not quantified the extent of the anticipated overperformance. They have reached agreement with the agricultural and transportation sectors on a package of tax measures valued at about 0.1 percent of GDP to compensate them for increased operating costs related to the higher price of oil. Notably, these measures do not reduce specific or ad valorem taxes on petroleum products, although the specific petroleum tax will not increase next year.¹ The net impact of these measures on the budget is likely to be minimal, as the staff anticipates they will be largely offset by higher VAT revenues on oil products. Through end-August, the deficit of the State government on a national accounts basis stood at 0.2 percent of GDP, compared to an annual target of 0.6 percent.

8. The 2001 budget was presented to Parliament in late September. As foreshadowed in the Staff Report, the proposed budget calls for overall public sector balance, with a social security surplus of 0.3 percent of GDP offsetting a State government deficit of the same magnitude, The budget is based on real output growth of 3.6 percent, compared to the revised 3.2 percent now projected by the staff.

9. These revisions do not alter the staff’s policy advice, which was to welcome the decision to accelerate fiscal consolidation this year and next, and to highlight that a move to structural balance in 2001 was both feasible and desirable. Given the likelihood that the 2000 deficit will be below the revised target, and that the projected decline in real output growth next year will be offset in nominal terms by expected higher inflation, no additional measures should be required to achieve nominal fiscal balance. Indeed, structural balance should also remain within reach: the actual fiscal surplus required to achieve structural balance would be very modest (on the order of about ¼ percent of GDP), implying only a slight improvement over the budget target.