Spain: Staff Report for the 2002 Article IV Consultation

This 2002 Article IV Consultation highlights that Spain experienced a second year of subdued growth in 2002—albeit at a rate still well above the euro area average. This was largely owing to the relative resilience of Spain’s domestic demand, which in turn was supported by a comparatively stronger showing of investment, sustained by booming construction activity and a continued public infrastructure effort. After having been the mainstay of the earlier upswing, private consumption lost momentum, as households coped with rising inflation and higher indebtedness.

Abstract

This 2002 Article IV Consultation highlights that Spain experienced a second year of subdued growth in 2002—albeit at a rate still well above the euro area average. This was largely owing to the relative resilience of Spain’s domestic demand, which in turn was supported by a comparatively stronger showing of investment, sustained by booming construction activity and a continued public infrastructure effort. After having been the mainstay of the earlier upswing, private consumption lost momentum, as households coped with rising inflation and higher indebtedness.

I. Introduction

1. The 2002 Article IV discussions took place with the government of Prime Minister Aznar entering the final year of its second mandate, having realized substantial structural reforms that have underpinned vigorous growth. For a number of years now, Spain has pursued policies largely in line with past Fund advice, characterized by a stability-oriented fiscal policy, extensive labor and product market reforms, and the maintenance of wage moderation. The growth and employment pay-offs have been evident, and entailed a significant narrowing of per capita income differentials with the euro area (Table 1 and Figure 1). In addition, by making judicious use of the expansion to improve its underlying fiscal position, Spain succeeded in complying with the Stability and Growth Pact (SGP) commitments as from 2001, in contrast to the experience of other major euro area countries. The new Budgetary Stability Law and permanent financing arrangements with the autonomous communities are serving to strengthen the medium-term fiscal framework, as sought by the Fund. Finally, banking supervision has been proactive and rigorous in the face of potential risks, and the authorities have agreed to undertake a Financial Sector Assessment Program (FSAP).

A01ufig01

Structural Balance 1/

(in percent of GDP)

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Source; IMF, World Economic Outlook.1/ Cyclically adjusted fiscal balance, excluding asset sales.
Table 1.

Spain: Main Economic Indicators, 1998–2003 1/

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Sources: World Economic Outlook; Information Notice System and Fund staff estimates.

Figures for 2002–03 are Fund staff projections.

Change as percentage of previous year’s GDP.

As of October 2002.

Year-on-year percentage change.

As of November 2002.

Figure 1.
Figure 1.

Spain: Nominal and Real Convergence, 1990–2002

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Sources: IMF, World Economic Outlook; World Bank, World Development Indicators; Organization for Economic Cooperation and Development; and Eurostat.

2. Nonetheless, performance in a number of key areas remains inadequate. These areas have been the focus of Fund advice going forward: both inflation and unemployment remain high, competitiveness vis-à-vis the euro area has been slipping, and regional income and unemployment dispersion is still pronounced. Much has been achieved to improve the workings of the labor market, but the recommended greater wage differentiation has remained elusive. The Fund has also pressed for a continued, even if gradual, phasing in of pension reforms to meet Spain’s comparatively late, but large, demographic shock. While steps have been taken, the reform momentum has been difficult to maintain.

3. This year will be punctuated by a series of local, regional, and European elections, culminating in general elections in the spring of 2004. In this setting, a preelectoral climate is taking hold. Prime Minister Aznar has declared he will not run again, but his successor at the helm of the center-right Partido Popular remains to be selected.

II. Economic Background

4. After a sustained expansion in the late 1990s, Spain has experienced a second year of subdued growth—albeit still well above the euro area average. This performance owes much to the relative resilience of Spain’s domestic demand, in turn due to a comparatively stronger showing of investment, sustained by a continued public infrastructure effort and booming construction activity. Private consumption—after having been the mainstay of the earlier upswing—stood up comparatively less well, as households coped with rising inflation, higher indebtedness, and some fiscal drag. The decline in equity values, fueled in some cases by the difficulties in Latin America (which otherwise had only a limited direct effect on the Spanish economy), also sapped consumer confidence. Finally, the impact of the trade shock was comparatively pronounced—due primarily to the economy’s exposure to the weakness in tourism (which accounts for 10–12 percent of value added, with a large contingent of German tourists) and possibly to the further loss in competitiveness within Europe (Figure 2).

Selected Economic Indicators, 2001–2003

(Real growth rates in percent, unless otherwise noted)

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Sources: World Economic Outlook and Fund staff estimates.

In percent of potential GDP.

Contribution to growth.

Figure 2.
Figure 2.

Spain: Competitiveness and Exports, 1990–2002

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Sources: IMF, International Financial Statistics; IMF, Direction of Trade; and Organization for Economic Cooperation and Development.

5. Recent high frequency indicators suggest that, despite some pickup, growth will remain below potential over the coming period. National accounts data through the third quarter of 2002 suggest that the slowdown in domestic demand may have reached bottom and begun slowly to recover—driven mostly by a gradual strengthening of investment, particularly due to robust construction activity. Private consumption slowed further, with consumer confidence weakening to its lowest level in several years and households appearing intent on reconstituting their savings, in the face also of slower employment growth and steadily rising unemployment. All in all, most projections (including by staff) concur in foreseeing only a rather gradual pickup toward potential growth (estimated at around 3 percent) in the course of 2003, yielding average annual growth of some 2½ percent.

6. Despite the weakening of aggregate demand and the larger output gap, inflation has risen and the inflation differential vis-à-vis the euro area average has widened. Inflation (HICP) reversed its moderating trend toward late 2001 and has since climbed steadily, reaching a 12-month rate of 4.0 percent in December 2002—corresponding to an inflation differential of 1¾ percentage points with the euro area. While the 12-month rate reflects some temporary factors, average inflation for 2002 is likely to be around 3½ percent, exceeding the euro area average by some 1½ percentage points—in excess of most estimates of any likely by-product of real convergence (see further discussion in ¶13 below).

7. A small general government deficit is now estimated for 2002, due to shortfalls at the regional level; the budget again aims for balance in 2003. At the time of the discussions, the authorities were counting on achievement of the targeted general government balance in 2002. Latest official estimates now point to a slight deficit (0.2 percent of GDP); a growing social security surplus (0.8 percent of GDP) is expected to counter a small central government deficit and more appreciable slippage by the autonomous communities (a deficit of 0.5 percent of GDP). An overall general government balance is again targeted for 2003 (Table 2). The authorities point, however, to continued uncertainty regarding the autonomous communities’ outcome in 2002 (with firmer data available only in February), and have indicated that the clean up costs for the recent oil spill could weigh appreciably on the 2003 budget.

Table 2.

Spain: Fiscal Accounts, 1998–2003

(In percent of GDP)

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Sources: Cuentas Financieras, Bank of Spain; Intervencion General de la Administracion del Estado;and Fund staff projections.

Excludes 0.1 percent of GDP received from the auction of mobile telephone licenses in 2000.

8. The policy mix is one wherein easy monetary conditions were accompanied in 2002 by appreciable fiscal withdrawal; a similar setting appears in store for 2003. Monetary conditions are clearly supportive: given Spain’s higher inflation, real interest rates are comparatively low—indeed, at an unprecedented low level in recent history—and the common monetary policy was accommodating even before the interest rate reductions of early December 2002. The fiscal policy stance was, in contrast, restrictive, with the estimated budget outcome for 2002 implying a withdrawal of around ½–¾ percentage points of GDP. For 2003, the balanced budget target is, as noted, based on relatively optimistic growth assumptions (3 percent) and, as such, is officially intended to entail a broadly neutral fiscal stance. Under the staff’s growth projection, achievement of the target would imply a further fiscal withdrawal (of around ½ percentage point of GDP).

III. Report on the Discussions

9. With the authorities having achieved notable progress across a broad range of areas, the discussions focused on the main economic priorities for the rest of the present government’s mandate. Within the overall objective of ensuring continued real convergence, the authorities’ main economic priorities to the end of the legislature were, first, to safeguard the achievements in the fiscal area, notably by pursuing nominal fiscal balance and implementing the Budgetary Stability Law (BSL), while proceeding with income tax reduction; second, to see through a series of reforms underway, particularly the recently approved modifications to the unemployment benefits regime, gradual changes to the pension system in agreement with the social partners, and the finalization of a series of initiatives to promote entrepreneurial activity and improve corporate governance. Staff supported these objectives but—while acknowledging Spain’s considerable progress since EU accession—it also noted that, given an unflattering starting position, important shortcomings persisted (see text table) and needed to be at the center of a continued structural reform effort.

Progress and Lagging Areas

(In percent unless indicated otherwise)

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This compares to 10, 18, and 22, respectively, for Belgium, Germany, and Italy.

A. Cyclical Outlook

10. The authorities expressed confidence in the economy’s ability to weather the current adverse economic climate and continue to grow appreciably above the EU average. Official projections place real GDP growth at 2.2 percent in 2002 and 3 percent in 2003, with driving elements of the latter being an estimated ½ percentage point boost to private consumption from income tax cuts and a continued public investment effort. (The 2003 budget incorporates income tax cuts for all brackets, centered particularly on lower incomes, and envisages a 13 percent nominal increase in capital spending.) While staff agreed that a recovery appeared to be in store, it held a less sanguine view of the prospects for private consumption, given households’ current financial situation and the depressed state of consumer sentiment. It accordingly projected lower real GDP growth of 2 percent in 2002, picking up to close to 2½ percent in 2003. These projections (in line with the December Consensus Forecasts) imply a further widening of the output gap in 2003 (to about 1½ percent of potential GDP). The authorities, in reviewing various risks to the outlook, concurred that these were prevalently on the downside and, in the update of the Stability Program presented in late December, a “less favorable” scenario postulates growth of 2 percent in both 2002 and 2003 (Table 3).

Table 3.

Spain: Updated Stability Program, 2002–06

(In percent of GDP, unless otherwise indicated)

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Source: Data provided by the Spanish authorities.

On an ESA95 basis.

11. The main shared concern regarded inflation performance and the maintenance of wage moderation. The authorities attributed a good part (some ¾ percentage points) of the rise in inflation since its low point in late 2001 to a series of one-off factors—including the introduction of the euro, increases in indirect taxes, and oil price rises earlier in 2002. While they anticipated a decline of inflation by the spring of 2003, as these effects receded, they were concerned that social agents would misinterpret the temporary rise in inflation and perpetuate its impact through increased wage demands in the upcoming negotiations. Furthermore, staff noted that the overshooting of the official inflation target (intentionally aligned to the ECB target of 2 percent to lower inflation expectations) risked further entrenching the recourse to backward-looking wage safeguard clauses, which already covered some 75 percent of workers. Staff also expressed concern about the demonstration effect provided by the relatively high wage increase granted to public sector employees—albeit following earlier rigorous moderation in this sector. At the time of writing, there is as yet scant information on the likely outcome of the current wage negotiations: while it appears that wage demands are contained, the recourse to safeguard clauses is likely to become more extensive—as had indeed been signaled by trade unions in the mission’s meetings.

12. The discussions reviewed a number of downside risks. As is the case more generally, Spain’s growth prospects are exposed to appreciable downside risks from the current geopolitical environment and potential further pressures on oil prices. The authorities estimated that a sustained 20 percent increase in oil prices would dampen growth by about 0.2 percentage points. In addition, one could not rule out “worse case” scenarios that could reduce global growth by considerably more, with a notable impact on an open economy such as that of Spain. The discussions focused on three other sources of downside risks seen as being particular to Spain, as follows:

  • Household indebtedness: EMU-related lower interest rates and the boom in mortgage and durable goods loans have pushed household indebtedness to new highs—from around 45 percent of gross disposable income in the pre-EMU period, to close to the euro area average of 80 percent by 2001 (Figure 3). The authorities viewed this adjustment as a normal structural shift to new financing conditions. Staff noted, nonetheless, that the rapidity of the rise in indebtedness could induce consumers to pull in their horns, possibly abruptly, in the face of softer employment prospects.

  • House price “bubble” With house prices increasing by double-digit levels for several years, many observers viewed the Spanish housing market as ripe for a correction. To date, however, the housing boom was seen to have provided an important offset to the effect on household wealth provoked by lower equity prices, especially given a much larger stock of housing wealth relative to that of equities. (Real estate assets account for approximately 70 percent of total household wealth.) By the same token, however, staff remarked that any sudden price correction could have a large impact on consumption. The authorities were less concerned: while anticipating a leveling off in prices and some possible decline in real terms, they did not view recent developments as reflecting a speculative bubble. Housing values were being driven by fundamentals, notably: increased demand generated by the durable change in financing conditions associated with EMU, the demographic profile of the Spanish population (younger than in other European countries, with the “baby boom” occurring in 1970–75), rising income levels, and increased housing demand by both immigrants and nonresidents (with a relatively high weight of residential tourism). In addition, staff saw generous tax relief on home purchases as a possible further factor shoring up demand, although such relief had been reduced somewhat over time. On the supply side, staff also pointed to rigidities in the availability of development land, and pressed for measures to address this bottleneck, given also its adverse impact on labor mobility.1 The authorities agreed, although they assigned somewhat lesser importance to supply constraints (noting that the supply of housing had doubled its historical annual average, to a rate of 500,000 new houses). They also recalled the constitutional difficulties encountered by earlier attempts to reform the laws on land supply. In meetings with parliamentarians, the latter suggested possible scope for a bipartisan approach to this issue.

  • The fall-out from the difficulties in major Latin American countries: the authorities noted that the direct channels through which such difficulties could affect the Spanish economy were limited. Direct trade linkages with Latin America are small (their share in total exports does not exceed 5 percent), while any retrenchment of investment plans by domestic companies exposed to the region would have a minor overall impact (with such companies accounting for only 2–3 percent of total investment). There had of course been an appreciable impact on major banks’ balance sheets (see Section C below), but the observed deceleration in domestic credit growth was seen to reflect both lower credit demand and increased bank caution to domestic risks—the latter being welcome, and in fact encouraged, by banking supervisors. The authorities noted that any risk of credit rationing by major commercial banks, which they considered to be small, was tempered by the prominent role of savings banks and other credit institutions in the financing of the economy. Staff concurred that the direct economic impact of Latin American difficulties had been—and was likely to remain—muted, but the related decline in the equity values of internationally active banks and companies had likely contributed to the weakening of consumer and business confidence, indirectly depressing consumption and investment.

A01ufig02

Real Residential Price Indices

(Log scale: 1992=100)

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Figure 3.
Figure 3.

Spain: Household Debt and Savings, 1995–2001

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Source: Bank of Spain.1/ Net saving equals total saving less principal payments.

13. There was considerable uncertainty about the extent to which comparatively higher inflation would affect real convergence. While the authorities shared staff concerns about the cumulative effect that a persistent inflation differential could have on the economy’s competitiveness, they did not view the problem as imminent. First, they noted that Spain had entered EMU at a competitive exchange rate, and pointed to the continued maintenance, or even some gains, in market shares. The relative stability of the current account balance was also viewed as a source of comfort (Table 4). Second, they were confident that the present spike in inflation would recede in early 2003 as the underlying one-off factors were reabsorbed. Third, and most importantly, they felt that the inflation differential could be largely attributed to a benign equilibrating adjustment process within monetary union. They agreed that the available data provided scant support to the Balassa-Samuelson hypothesis, with Spain’s productivity relative to the euro area appearing to have fallen in recent years (Box 1). But they noted that extensive data revisions were underway and that, once completed in 2003, they could well yield a more intuitive result on this score. Staff concurred that part of the inflation differential could be deemed a by-product of real convergence,2 and there was agreement that, once data revisions were completed, more research would be needed to understand the causes of inflation.

Table 4.

Spain: Balance of Payments, 1998–2002

(in percent of GDP)

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Source: Bank of Spain.

14. But staff also pressed the need to address the supply rigidities stemming from inadequate competition in specific services sectors, where the convergence process was likely to be prompting relatively stronger demand pressures. Despite a lack of empirical studies, there was general agreement that the catch-up in income levels was likely to produce an unevenness in the pressure of demand, hitting services and nontraded goods prices harder. In this setting, staff expressed concern about the obstacles to the required supply response in the services sector. In particular, in an effort to protect local markets and small retailers, regions (to whom relative competencies had been devolved) had been imposing increasing barriers to entry in retail distribution and trade. The sector’s ability to increase its profit margins—relative to those prevailing in sectors exposed to international competition (notably manufacturing)—was suggestive of inadequate competition as contributing to the stubbornness of inflation (see Box 1).

Inflation, Productivity, and Profit Margins

Spain’s inflation differential with the euro area average widened to about 1½ percentage points for most of 2002, and has averaged about 1 percentage point in the decade ending in 2002. In consequence, the real exchange rate (both CPI and ULC based) vis-à-vis the EU has shown a steady appreciating trend. The extent to which these developments raise real convergence issues depends on whether equilibrium factors are at play:

  • The Balassa-Samuelson (B-S) effect—the impact of wage increases on nontraded goods prices caused by relatively higher productivity increases in traded goods—is an often-cited equilibrium explanation for inflation differentials in monetary union. In Spain, however, labor and total factor productivity relative to the EU have declined (see figure), and the bulk of empirical studies—Estrada and López-Salido (2001) and Rogers (2001) and references therein—have had difficulties in reconciling the Spanish data with this effect. Currently, productivity and related data shortcomings are being examined, and data revisions are underway.

  • Convergence of nontraded goods prices as income levels rise is a natural outcome of real convergence. As households become wealthier they demand relatively more services (medical, entertainment, etc.) pressuring nontraded goods prices. This is consistent with non-homothetic preferences, and indeed some empirical evidence suggests that a household’s income share of nontraded goods increases as income rises. This effect, however, has received limited empirical attention in the context of monetary union.

A01ufig03

REAL EXCHANGE RATE AND RELATIVE PRODUCTIVITY 1/

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

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RELATIVE INFLATION AND OPERATING SURPLUS 2/

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

  • Weak competition in the service sector appears to be a feature of the Spanish inflation experience. The difference between service and manufactured goods inflation has followed closely the evolution of service sector profits relative to those of manufactured goods (see figure). A body of empirical evidence points to the evolution of markups in the non-traded sector as a key element behind the inflation differential—see Andrés, Ortega and Vallés (2002), and references therein. This evidence suggests that supply-side rigidities in services have indeed inhibited effective competition. Moreover, in this context backward-looking clauses in wage contracts can contribute to the persistence of the inflation differential, as noted in Benigno and López-Salido (2002) and Gali and López-Salido (2001).

These trends could hinder the economy’s ability to continue coping with an international environment that promises intensified competition as EU enlargement proceeds. Nonetheless, a definitive judgment on the extent to which the inflation differential may be attributed to a benign equilibrating phenomenon will need to await the results of data revisions expected in 2003.

Source: European Commission and Bank of Spain.1/ Spain relative to the European Union.2/ The relative inflation differential (operating surplus) is defined as the rate of inflation (growth of the operating surplus per unit of value added) of the service sector minus that of the industry sector.

B. Fiscal Policy

15. With the general government close to balance in 2001–02 and with a “zero deficit” again targeted for 2003, the fiscal discussions focused on the conduct of policy under the new Budgetary Stability Law. The Law mandates budget balance at the various levels of government.3 The authorities placed primary emphasis on the disciplining effect of this requirement, and viewed the restraining role of a clear fiscal target ("zero deficit") for all levels of government as an over-riding consideration. This was especially the case in the current transitional phase to new arrangements and in the first year of application of the BSL. They were consequently wary of formulations such as those used by staff (notably its advocacy of a “flexible” i.e., cyclically sensitive implementation of the BSL). They furthermore noted that the simplicity of the “zero deficit” target had evident appeal and, according to polls, considerable public support. Accordingly, in 2002, they had pursued this target unwaveringly, largely irrespective of changes in growth prospects. Although some slippage at the regional level is now estimated to have entailed a small overall deficit, this policy stance resulted—in the staff’s calculations—in an appreciable withdrawal of fiscal stimulus (text table and Figure 4).

Figure 4.
Figure 4.

Spain: Fiscal Stance, 2000–03 1/

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Source: IMF, World Economic Outlook.1/ Measured by the change in the structural primary balance.

Budget and Outcomes, 2000–03

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Statt estimates.

Change in structural balance.

16. Staff appreciated the importance of ensuring overall fiscal discipline, but also drew attention to the need to be responsive to cyclical developments. It fully agreed that cyclical flexibility should not be misconstrued as a license for fiscal laxity, and that it was important to observe the newly introduced ceilings on central government spending. At the same time, it cautioned against an undue focus on nominal fiscal targets, noting that the vicissitudes of the SGP illustrated the potential shortcomings—both in upswings and downswings—of such a focus. Staff also presented empirical results that illustrated the magnifying impact of a fixed nominal budget target on Spain’s already high output volatility (Box 2 and Selected Issues paper). It accordingly encouraged the authorities to use the flexibility available under the Law (i.e., the possibility of departing from budget balance in “exceptional circumstances,” subject to the presentation of a viable three-year adjustment plan) to take appropriate account of cyclical developments.

17. The authorities explained their firm adherence to the “zero deficit” target and related wariness vis-à-vis the full play of automatic stabilizers on various grounds. They did not disagree that Spain’s achievement of the SGP commitments provided scope for the use of automatic stabilizers. The updated Stability Program indeed postulates a different fiscal path under a lower growth scenario (i.e., a deficit of 0.4 percent of GDP in 2003 if growth were 2 percent—instead of the central scenario’s 3 percent—Table 3). Nevertheless, in addition to the above-noted emphasis on the BSL’s disciplining function, the authorities pointed to other factors underlying their guardedness with respect to the role of automatic stabilizers. First, they noted that the well-known difficulties in estimating cyclically adjusted balances were compounded in Spain by a number of ongoing structural shifts (among which, for example, the regularization of a large number of immigrant workers, making for a surprising buoyancy of social security receipts in the midst of the economic slowdown). Second, they noted, the July 2002 ECOFIN Council had recognized these difficulties and exempted Spain from moving to a production function method to estimate the structural balance.4 Third, they explained that the 2002 budget had been based on clearly cautious revenue projections, so that achievement of the target (then apparently at hand) had not required any discretionary action despite significantly lower-than-anticipated growth.5 A similar safety margin had been built into the 2003 budget. Regarding the latter, staff noted that, under its less sanguine growth projection, the emergence of a small general government deficit resulting from purely cyclical factors (around ½ percent of GDP) would be consistent with the budget’s intended neutral stance. With the further relaxation of monetary policy since the mission, the fiscal withdrawal implied by the balanced budget target would not be problematic per se. In the staff’s view, however, the persistent inflation differential needed to be addressed through a continued pursuit of the structural reform agenda, discussed further below.

The Macroeconomic Effect of Fiscal Shocks in Spain

A background study for the consultation illustrates the higher output volatility in Spain in the 1990s compared with other advanced economies, and the extent to which pursuing a fixed nominal budget target would further increase such volatility. Specifically, Spain’s average (absolute value) output gap is among the highest in the OECD. Likewise, the standard deviations of output growth, private consumption, and investment rank among the highest in euro area countries. The empirical evidence suggests that a tax cut (or an increase in public spending, both of a size corresponding to historical experience) leads to an expansion of output that develops over the course of a year to six quarters, with investment responding more forcefully than private consumption. Also, the evidence—consistent with the Keynesian view of fiscal policy—indicates that the pursuit of a nominal budget target would, by curbing the automatic stabilizers, contribute to exacerbating output shocks. In the case of Spain, this adverse effect mainly reflects the suppression of the counter-cyclical impact exercised by stabilizers on the revenue side.

The staff study was presented in a seminar during the consultation, with the authorities and participants making the following main points:

  • EU entry has entailed important changes in the characteristics of cyclical developments. These were attributed to a reduction in the uncertainty of macroeconomic policies and economic prospects, and to Spain’s greater integration in Europe. Thus, Spain’s standing among OECD countries with the highest volatility is likely to have changed.

  • Even taking the greater volatility at face value, the role of fiscal policy is unclear. By focusing on fiscal policy, the staff study seems to argue implicitly that fiscal policy had contributed to the higher observed macroeconomic volatility. Seminar participants noted that structural features (such as labor market rigidities) were more likely to underlie the economy’s volatility. Also, the greater importance of the agricultural and tourism sectors in Spain entails a relatively greater exposure to supply and external shocks.

  • Moreover, the substantial fiscal consolidation of the past decade has crowded-in investment and provided a boost to economic growth. Although the econometric methodology is useful to examine business cycles and the dynamic impact of fiscal policy, it does not account for the medium-term impact of fiscal policy. Seminar participants noted that fiscal consolidation—effected in tandem with the drive to EMU membership—had reduced real interest rates dramatically, stimulating a host of investment projects. These effects are likely to reduce the overall volatility of the economy and are not captured by the empirical evidence discussed.

Staff agreed that output volatility had fallen significantly in recent years—placing it closer to the EU average—but it remained above that of other major European countries. Also, the study should not be viewed as an indictment of fiscal policy, and structural characteristics are indeed likely to be an important factor underlying volatility. Still, it is unlikely that these considerations eliminate the beneficial effects of a cyclically sensitive implementation of fiscal policy under the Budgetary Stability Law, allowing full play of automatic stabilizers to cushion cyclical fluctuations.

18. The authorities noted that 2003 would be a milestone year for the new fiscal framework, with the first budget to be drawn up under the BSL and further steps in devolution. The year would see the completion of the transition to the permanent financing arrangement for autonomous communities, the full decentralization of health services, and the introduction of a new financing system for municipalities.6 In addition, the authorities pointed to two key features of the budget. First, a further reform of the personal income tax, which went beyond a mere cut in rates (in an amount equivalent to about ½ percentage point of GDP) and aimed to provide supply-side incentives (affecting, for example, female labor market participation and geographical labor mobility); and second, a continued strong public investment effort to meet Spain’s substantial infrastructure needs, raising the share of public capital spending in GDP to over 5 percent.

19. Given the various innovations under way, there was recognition of the importance of careful monitoring and fiscal transparency. There was agreement on the pressing need to improve the timeliness of information on the execution of regional budgets. With the devolution of health care to regions, the central government would account for no more than 40 percent of public expenditures, and yet—other than debt figures published by the Bank of Spain—there was no in-year information on the evolution of regional budgets. The authorities were in the process of strengthening regional reporting requirements, as stipulated by the BSL, and aimed to bring these efforts to fruition in the course of 2003. A second issue concerned the significant proportion of public investment carried out by public entities outside the general government, partly financed through capital injections. Staff pressed that the transactions and accounts of all such entities should be fully transparent and available on a timely basis, so as to rapidly reveal any risk of future debt liabilities. The authorities noted that such operations met Eurostat standards and were reported in budget documents, and provided data reconciling the discrepancy between the evolution of the deficits and the public debt stocks.7 Finally, staff noted that the considerable prudence exercised in the estimation of revenues—which the authorities defended as cautious budgeting and a means to contain expenditure pressures—complicated the assessment of the budget (already affected by the inherently difficult comparability problems arising from the shifts in financing and competencies). In its view, transparency required a closer consistency between revenue estimates and the budget’s underlying economic assumptions.

The demographic shock

20. With the budget broadly in balance, the issue now was to define an appropriate medium- to longer-term fiscal objective in light of population aging. The authorities stressed the difficulties of long-term population projections, compounded in Spain by the uncertainty of immigration flows (on which further work was underway). Nonetheless, it was evident that Spain’s demographic shock exhibited two special features compared with other EU countries: it would start unusually late (after 2020), but it was—given low fertility rates and high life expectancy—set to be unusually deep. The authorities saw the former feature as allowing for a gradual approach to social security reform, in a consensual process with social partners. Staff agreed, but noted also that the magnitude of the demographic shock indicated that the reform process could be gradual only if it started early enough, was continuous, and sufficiently ambitious. Following on the 2001 reforms (centered on incentives for workers to stay longer in the work force), little further action had been taken. The authorities—without prejudging the results of talks with the social partners—were hopeful that these would mark further progress in 2003, possibly including a strengthening of the link between contributions and benefits. Staff noted that gradually raising the effective retirement age by some five years, would, in tandem with stronger incentives to forego early retirement, have a major impact.

A01ufig05

Increase in Dependency Ratios 1/

(In percentage points)

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Sources: Bank of Spain; and Social Security Agency.1/ The dependency ratio (number of pensioners over contributors) in Spain was about 50 percent in 2001.

21. Provided social security reform was sufficiently ambitious, a small budget surplus would be an appropriate medium-term fiscal objective for Spain. There was general agreement that a moderate general government surplus, in the order of ½ percentage point of GDP over the cycle, would contribute appropriately—along with entitlement reform—to addressing aging pressures by reducing public debt.8 An added benefit of such a target, staff noted, would be to provide some cushion for cyclical fluctuations, while adhering to the letter of the BSL. Staff developed debt sustainability scenarios (Table 5) showing a public debt profile that is robust to aging pressures through the end of the decade, but rising sharply after 2020 as the demographic shock takes hold. Likewise, the stress tests suggest that the debt profile does not appear to be vulnerable to potential macroeconomic distress.9 These numbers are illustrative of the pressures facing fiscal accounts in the baseline scenario, i.e., a passive projection. In practice, adherence to the policy commitments under the SGP and the BSL would prevent debt ratios from rising as shown in Table 5 but, in the absence of pension reforms, would require significant cuts in non-pension spending.

Table 5.

Spain: Public Sector Debt Sustainability Framework, 1997–2007

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General government. Projections are based on current benefits and contributions to the pension system; population projections reflect immigration of 160,000 people annually through 2020.

For comparability with previous years, the calculation of the change in 2010, 2020, 2030, and 2040 corresponds to the change from the previous year, respectively 2009, 2019, 2029, and 2039.

Defined as: r = interest rate;π = GDP deflator, growth rate; g = real GDP growth rate.

Real appreciation is approximated by nominal appreciation against U.S. dollar plus increase in domestic GDP deflator.

C. Developments in the Financial Sector

22. The authorities noted that the banking sector remained profitable and well capitalized, and that strict supervision had ensured its resilience during a difficult period. The discussions with supervisory authorities and market participants confirmed that major Spanish banks had weathered the difficulties stemming from their investments in Latin America reasonably well. Such resilience was attributed to their strong starting positions, with capitalization (BIS ratio of 13 percent) and profit ratios (ROE of 17 percent) exceeding those of the average European bank (BIS and ROE of 11 and 16 percent, respectively), as well as high efficiency ratios. In addition, banks enjoyed strong domestic franchises and diversified activities, centered on relatively low-risk domestic retail markets, with little exposure to IT or insurance sectors. The mission’s interlocutors noted that these underlying strengths were reinforced by the strict prudential and supervisory approach of the Bank of Spain, which had played an active role in promoting conservative risk management practices. Indeed, the mission found considerable market appreciation for the Bank of Spain’s supervisory role, in a climate of close cooperation between supervisors and market participants.

23. In this setting, major banks had been able to deal with the difficulties stemming from Latin America, with the main casualty being a reduction in profit growth. Spanish banks’ direct exposure to Latin America is sizable (Box 3). Their consolidated foreign claims in the region amount to US$157 billion (32 percent of the total), and are concentrated mainly in Mexico, followed at a considerable distance by Brazil, Chile, and Argentina. Spanish banks’ foreign direct investment in the region is also substantial (in excess of US$20 billion). Banks are furthermore exposed indirectly to Latin America through their business with Spanish companies that are active in the region—although, the authorities noted, such exposure was relatively limited. Loan exposures to Latin America have been provisioned according to fairly strict requirements, including via the “forward-looking” provisioning introduced in 2001.10 The value of the banking sector’s investments in Argentina has also been adjusted downward to reflect the peso’s devaluation, and acquisitions (book value and goodwill) have also been fully amortized under an accelerated timetable. All in all, the major banks involved had thus been able to absorb the Argentine crisis while remaining profitable, with timely reassessments of earnings prospects helping to avoid market surprises. These results had been achieved, the authorities noted, despite developments in Argentina that had been significantly more adverse than initially anticipated. Nonetheless, given their greater exposure, major Spanish banks’ equity valuations had suffered relative to those of European and U.S. banks (Figure 5).

International Consolidated Claims on Latin America

(end-June 2002)

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Source: BIS
Figure 5.
Figure 5.

Spanish, European, and U.S. Bank Stock Indices, 2000–03

(100=Dccember 31, 2000)

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Sources: Bloomberg and Datastream.

Exposure to Latin America

Spanish banks’ direct exposure to Latin America is sizable: the region generates about one-third of net earnings, and constitutes about a third of group loans and deposits. Market reports indicate that the two largest banks (Banco Bilbao Vizcaya Argentaria-BBVA and Santander Central Hispano-SCH) have invested between US$20-25 billion in building a banking network in the region. In some countries—Chile, Colombia, Mexico, and Peru—they account for 20 percent or more of the commercial banking market. The Spanish banking sector’s consolidated foreign claims in the region amount to US$157 billion (32 percent of the total, slightly above the U.S. share of 26½ percent). They are concentrated mainly in Mexico (56 percent of Spain’s total exposure to the region) followed by Brazil and Chile (13 percent each), and Argentina (6½ percent). Spanish banks’ vulnerability to liquidity pressures in their overseas subsidiaries, and the potential costs of recapitalization over the medium-term (as opposed to a write-off) could, if incurred, far exceed their direct investments and may have adverse ratings consequences.

Spanish and International Consolidated Foreign Claims on Latin America

(end-June 2002)

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Sources: BIS; and Bank of Spain.Note: Includes local claims of reporting banks’ foreign affiliates denominated in local currency amounting to a total US$117.5 billion.

24. A similar proactive approach was being pursued to deal with other potential risks, and the authorities were confident that the situation would remain manageable. Although a deterioration of financial conditions in Brazil would put considerable pressure on banks’ balance sheets, the authorities were of the view (shared by most market analysts) that—barring a generalization of the risks to much of Latin America—the impact on the Spanish banking sector would remain manageable. For their part, major banks reiterated their interest in remaining in Latin America for the long haul. All in all, the discussions provided reasonable reassurance that, under currently plausible scenarios, events in Latin America were not poised to raise systemic risks for the Spanish banking system. On the domestic front, concerns, shared by staff, centered on the risks posed by the rapid rise in mortgage lending and the related increase in household indebtedness. Such risks were however viewed as tempered by a lesser increase in the related financial burden (due to lower interest rates, longer average repayment terms, and the greater prevalence of two-income families). Nonetheless, the Bank of Spain had been vocal in its calls for caution with respect to mortgage lending and welcomed recent signs of deceleration in its growth. In this context, the authorities agreed to undertake a FSAP at a mutually determined time.

25. The authorities also pointed to recent legislation modifying important aspects of the status and capital structure of the savings banks. The cajas de ahorro segment of the banking sector consists of a large number of mostly small- and medium-sized institutions that concentrate on retail business. Their activities, characterized by geographical focus and close client relations, were seen to provide the system with an important element of risk diversification. Nonetheless, their particular status (not-for-profit foundations), ownership structure, and close ties to local and regional governments had long been seen as posing “level-playing-field” and governance issues. Following a protracted process, adjustments had recently been made to their statutory framework. These had been designed to reduce political presence in the savings banks’ governing bodies and to allow the cajas to issue a form of nonvoting “stock” (cuotas participativas). These instruments will provide holders with a right to a share of the profits and are to be listed on the stock exchange. Besides endowing the cajas with a means to strengthen their capital structure (the new instruments qualify as Tier 1 capital), the cuotas are intended to provide a market assessment of individual savings banks’ management performance. Staff noted that the degree to which such market discipline would indeed be effective will, however, depend on the extent to which these instruments would be perceived, and in practice behave, as variable return instruments entailing capital risk—a matter on which some market participants harbored doubts.

D. Labor and Product Markets

Labor markets

26. Staff commended the much improved performance of the labor market—with unprecedented job creation even during the slowdown—and discussions focused on recent initiatives and remaining needs to address a still high level of unemployment (Figure 6). Fallowing on a series of reforms, the major recent labor market initiative concerned changes to the unemployment benefits system to promote a “return-to-work” orientation and greater geographical mobility. The initial reform proposals, which had met with considerable trade union opposition, were modified in the course of 2002, but the authorities were satisfied that their main elements had been preserved. Active job search is to be promoted through an “activity contract” (compromiso de actividad), setting out the worker’s right to receive personalized service and training through the public employment office, but also establishing loss of benefits (after 100 days from the date of lay-off) in case of nonparticipation in such training or refusal to accept a suitable job within a 30 kilometer radius. The reform also contains provisions covering dismissal costs, which employers saw as reducing the uncertainty attached to the traditionally protracted judicial process, but as leaving the high level of such costs largely unaffected. A final important element of the reform—still facing strong trade union opposition—concerns the phasing out of the rural employment subsidy, which has long acted as an impediment to labor mobility out of agriculture in the beneficiary regions (Andalucia and Extremadura).

Figure 6.
Figure 6.

Spain: Unemployment by Regions, 1990–2002

Citation: IMF Staff Country Reports 2003, 040; 10.5089/9781451812053.002.A001

Source: Bank of Spain.

27. The staff welcomed the reform’s “return-to-work” emphasis and supported the phasing out of the rural employment subsidy. It noted that experience elsewhere suggested that the success of such reforms lies in their practical implementation, i.e., in the capacity of the public employment services both to assist active job search and to suspend benefits when required. It would be accordingly important to modernize the public employment office and monitor experience, making adaptations as needed as the new system is implemented.

28. As to next steps in labor market reform, there was agreement on the need for changes in Spam’s collective bargaining system. Various features of the system were seen to be in need of reform. First, a level of negotiation centered on sectoral agreements had led to a high homogeneity of wage increases across sectors and firms, exacerbating regional unemployment problems. Although individual firms could in principle opt-out of such agreements, the authorities noted that this was extremely rare in practice. A second issue of shared concern regarded the continued and widespread recourse to backward-looking wage indexation clauses. Overcoming resistance to phasing them out would however, staff noted, required that the reference value for wage negotiations be seen as a reasonably realistic reflection of expected inflation. Finally, staff was critical of the practice whereby, in the absence of negotiations or agreement, a labor contract’s provisions remain in effect indefinitely (known as ultra actividad). This was a serious disincentive to broader discussions, focusing negotiations almost exclusively on the salary increase, at the expense of other key issues (e.g., the flexibility of work organization, productivity improvements, training, etc.). The authorities also viewed this practice as inhibiting a broad social dialogue, but noted that legal complexities risked standing in the way of substantive changes.

Product markets

29. Progress in reforming product markets is well-advanced, in keeping with an ambitious plan adopted in 2000, but effective competition in certain key network sectors remains elusive. Spain’s record in transposing internal market legislation is among the best in the EU and it ranks favorably under a set of OECD measures of product market liberalization (Table 6). Nonetheless, in key network services, competition remains low with, for example, a still large market share of incumbents in fixed telecommunication and gas, and a reduced number of operators in the wholesale market for electricity. The authorities recognized these limitations, and reaffirmed their commitment to enhancing competition—recently, for example, taking major electrical companies to the Competition Tribunal for alleged price-fixing behavior. They also noted, however, that further progress in this area was partly dependent on greater liberalization throughout Europe, with underlying concern about entry by entities that still enjoy a virtual monopoly in their home markets.

Table 6.

Product Market Regulation in Spain and Other Selected Economies, 1998 1/

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Source: OECD.

Scale of 0 to 6 from the least to the most restrictive.

30. There was shared concern about the obstacles to effective competition arising from initiatives by the regions, notably in retail trade and distribution. A number of regional and local entities have made increasing recourse to a variety of barriers to entry and competition in retail distribution and trade. Such barriers range from outright prohibitions for super or hypermarkets, complex regulations, overlapping and discretionary licensing requirements, and limitations to opening hours. Staff called for the removal of all such obstacles, given also their above-noted role in upholding supply rigidities in a sector that was likely subject to relatively greater demand pressures in the convergence process. In a similar vein, staff noted the risks to the coherence of national competition policy posed by the creation of new competition tribunals at the regional level. The authorities responded that it was unlikely that all regions would set up such tribunals, and also pointed to the creation of a Council for the Defense of Competition—encompassing regional competition authorities—to ensure overall coordination. Nonetheless, while largely agreeing with the points raised by staff, the authorities noted the difficulties posed by the devolution of the relative competencies to regional and local authorities. In this regard, they welcomed staff’s call for greater “co-responsibility” of the regions in this area (akin to that in the fiscal area), and suggested that future consultation discussions engage selected regional authorities.

31. Various initiatives were underway to promote entrepreneurial activity and improve corporate governance. Among the former, the authorities highlighted first, a draft law (Ley de Nueva Empresa) designed to lighten the administrative burden in the setting up of new companies, reducing the related time and costs; and second, a new bankruptcy law, modernizing a severely outdated regime that provided virtually no relief to enterprises in distress, often leaving small- and medium-sized firms with no option other than closure. On corporate governance, a special Commission (Comisión Aldama) was at work to reflect the recommendations made at EU level (by the High Level Group of Company Law Experts), and was expected to report by early 2003. Relatedly, a working group is due to elaborate a White Book with specific recommendations to align Spanish accounting practices to international standards and relevant EU directives.

E. Other Issues

32. The authorities reaffirmed their strong commitment to efforts to counter money laundering and the financing of terrorism. Spain is a FATF member subject to mutual evaluations and has an extensive system of legislation and regulations for anti-money laundering and combating the financing of terrorism (AML/CFT). Supporting institutional capacity and arrangements for international cooperation are also generally well-developed. The authorities, who responded in detail to the Fund’s questionnaire on AML/CFT issues, expect that legislation further refining provisions in this area will be passed early in 2003. They expected Spain to be in full compliance with the EU’s anti-money laundering directive by June 2003, and noted that Spain has provided technical assistance to a number of countries to help them develop their AML/CFT capacity.

33. The authorities expressed Spain’s support for trade liberalization vis-à-vis the least developed countries and for the success of the Doha round. They reaffirmed their support for the “Everything But Arms” initiative and pointed to the ambitious objectives that Spain had presented at the outset of the Doha trade conference. In this regard, they noted Spain’s commitment to ensure that the Doha round be an effective instrument in promoting sustainable economic development, reflecting the interests of all countries within a balanced agreement. On reforming the Common Agricultural Policy (CAP), while having reservations vis-à-vis some of the European Commission’s proposals under the midterm review, they expressed openness to examining all proposals that would be put on the table. With regard to the reform’s possible impact on Spain, they felt that the details were as yet insufficiently specified to arrive at any reliable assessment. Staff illustrative simulations suggest that trade liberalization in agriculture would have an expansionary effect on Spanish output and consumption as the allocation of resources improved, although not without some retrenchment in employment in some agricultural sectors. The authorities noted, in this regard, that the modifications would include a second pillar aimed at strengthening rural development, which would help transition costs for Spain.

34. Provisional figures for 2001 indicate a sharp increase in Spain’s ODA, to a level equivalent to about 0.3 percent of GNI (12th among Development Assistance Committee (DAC) countries). A large share of Spain’s ODA goes to low-income countries in Latin America. A recent DAC Peer Review noted the relatively high share of loans in Spain’s ODA and recommended that this policy be reviewed in light of the enhanced HIPC initiative and efforts to restore debt sustainability. Spain has been an active partner in the Fund’s poverty reduction efforts, contributing to the PRGF and HIPC initiatives.

IV. Staff Appraisal

35. Spain’s recent economic performance stands as testimony to the pay-off of sound policies across a broad swath. A stability-oriented fiscal policy, extensive product and labor market reforms, and continued wage moderation have led to a remarkably high output and employment growth during the latest upswing. Despite the current deceleration, real GDP growth is set to remain well above that of the euro area in 2002–03. More telling still, employment has continued to expand even as the economy has cooled—an experience that stands in marked contrast to earlier slowdowns, when growth would fall below the EU average in the midst of sizable job destruction. For its part, a prudent supervisory approach has contributed to banking sector resilience through difficult times.

36. These positive results provide the best motivation for continued resolute action on the structural front, essential to future prospects. Despite the notable progress achieved, performance in a number of key areas remains unfavorable. As the stimulus of EMU-related lower interest rates fades, and with enlargement due to bring new competitors and reduce EU transfers, continued real convergence depends critically on placing growth prospects on a firmer medium-term footing. This will require, in particular, lifting remaining obstacles to strong employment growth throughout Spain and increasing competition in key sectors, in concert with the territorial authorities.

37. Short-term growth prospects are relatively favorable, although economic activity is likely to remain below potential and risks are on the downside. Highly supportive monetary conditions and income tax cuts appear set to sustain a gradual pickup in activity in the course of 2003. Nonetheless, apart from the uncertain external environment, Spain faces a number of country-specific downside risks, arising from households’ increased indebtedness, the boom in housing prices, and the greater exposure to Latin America. In all of these areas, there are grounds for confidence that the likelihood of significantly adverse economic repercussions for Spain is relatively low. Of greater concern, albeit for the medium term, is the cumulative effect of a persistently large inflation differential with the euro area.

38. Alone among the larger euro area countries, Spain has brought its fiscal accounts in compliance with the SGP commitments. This contribution to the smooth workings of EMU is most welcome, as is the new Budgetary Stability Law, which is designed to lock in the gains achieved in fiscal consolidation by mandating budget balance at all levels of government. As devolution advances, the authorities’ emphasis on fostering fiscal co-responsibility and instilling fiscal discipline throughout Spain is well-placed.

39. Going forward, there is a need to guard against the risk of unduly pro-cyclical policies under the Budgetary Stability Law. Under current prospects, given very easy monetary conditions, the withdrawal of fiscal stimulus implied by the official “zero deficit” target for 2003 would not be problematic from a macroeconomic perspective. But, over time, it is important to avoid implementing the Budgetary Stability Law in a manner that is unduly procyclical. In this regard, the Law’s focus on a nominal target that is not contingent on growth outcomes is not a cyclically robust framework over time. Furthermore, policy-makers at all levels should be prepared for the prospect that, once growth resumes with greater vigor, nominal surpluses would be required to avoid eroding the underlying fiscal improvement. In sum, well-considered cyclical flexibility in the implementation of fiscal policy under the BSL would provide the best guarantee for safeguarding fiscal consolidation, in both good and bad times, and a sustainable basis for building fiscal co-responsibility with the regions.

40. Given the fiscal innovations being introduced, careful monitoring and transparency are of the essence. There is, first, a pressing need to address the lack of timely information on the execution of the regional budgets—a shortcoming that continues to affect estimates of the 2002 outcome. Efforts to implement strengthened reporting requirements should thus be stepped up and come to rapid fruition. Second, given the growing proportion of public investment being carried out by public entities outside the general government, it is important for accountability and monitoring to ensure that their financial accounts are fully transparent and available on a timely basis.

41. Longer-run fiscal challenges are considerable and still largely unaddressed. There is agreement that, while Spain’s demographic shock will occur comparatively later, it is also set to be deeper. In preparing to deal with this shock, fiscal consolidation has advanced but pension reform has lagged. The contribution of the former can and should progress further, with a small surplus (in the order of ½ percentage point of GDP over the cycle) appearing to be an appropriate medium-term fiscal objective. But its adequacy is also contingent on substantive pension reform, and the talks with social partners in 2003 should lead to gradual but far-reaching changes that start early and can be phased in over time, avoiding more painful changes later. A powerful impact can in particular be had by gradually raising the effective retirement age, via stronger incentives to forego early retirement and a strengthening of the link between contributions and benefits.

42. In the banking sector, the salient feature is the resilience it has shown during a difficult period. This outcome reflects the banking sector’s strong starting position in terms of capitalization, provisioning, efficiency, and profitability, based on a vibrant domestic franchise, and is also the result of the Bank of Spain’s active promotion of conservative risk management practices. Although external risks remain, especially in the event of more extreme scenarios, the banking system’s overall sound position and the continuation of a vigilant supervisory approach provide reasonable assurance—reflected also in analysts’ assessments—that such risks will remain manageable. This seems to hold also for potential domestic risks, notably some price correction in the housing market; a further deceleration in the growth of mortgage lending would however be desirable. In this context, Spain’s readiness to undertake an Financial Sector Assessment Program (FSAP) is warmly welcome.

43. The improved performance of the labor market has been a heartening feature of recent years. Spain however still lags the rest of Europe in key indicators of labor market performance, and the government’s continued attention to labor market issues, expressed most recently in the reform of the unemployment benefits system, is thus welcome. The most significant labor market issue that the social partners and the government should now address is that of the organization of Spain’s collective bargaining system. There are three features of this system that merit revision: first, the need for greater wage differentiation, as one element in addressing the marked regional disparity in unemployment; second, the widespread existence of backward-looking wage safeguard clauses, a heritage of a high-inflation past that does not sit well with the requirements of monetary union; and third, the practice whereby, in the absence of agreement, a contract’s provisions remain in effect indefinitely—with negotiations thus focusing almost exclusively on the salary increase, impoverishing the content of collective bargaining. The social partners are encouraged, while pursuing a new, moderate collective wage agreement for 2003, to enlarge their discussions to embrace the issues noted above.

44. In goods and services markets, there is an increasing sub-national dimension. It is nonetheless evident that a nationally coherent policy affecting such markets is crucial to enhancing Spain’s overall economic performance, and avoiding that a policy intention of liberalization and deregulation at the central level be foiled at other levels. The same model of co-responsibility that imbues the fiscal agreement should thus be extended to goods and services markets. As a priority, the numerous barriers to more effective competition in retail distribution and trade need to be lifted. In a similar vein, the difficult but crucial issue of land supply needs to be revisited. In network services, liberalization has advanced but competition needs to be further enhanced in certain key sectors that remain dominated by incumbents.

45. Spain is well-advanced in its reflections on corporate governance and accounting rules and principles. The initiatives in these areas are welcome. Spain has also advanced commendably in the implementation of measures to counter money laundering and combat terrorist financing.

46. Spain is encouraged to build on the increase in ODA in 2001 and progress further toward the 0.7 percent of GNP benchmark; its contribution to the Fund’s initiatives for its poorest members is also valued. Finally, staff welcomes Spain’s support for trade liberalization vis-à-vis the least developed countries and its commitment to the success of the Doha round. In this regard, the authorities are encouraged to work in favor of the related internal reforms of the CAP in the midterm review. While in pure budgetary terms Spain is a net beneficiary of the CAP, liberalization is likely to benefit Spanish consumers and the economy as a whole.

47. Spain’s data are adequate for effective surveillance, although the quality of productivity data and the timeliness of regional fiscal data need to be improved (Appendix II).

48. It is recommended that the next consultation be held on the standard 12-month cycle.

Table 7.

Spain: Indicators of External and Financial Vulnerability 1/

(In percent of GDP. unless otherwise indicated)

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Sources: Bank of Spain, Economic Bulletin and Statistical Bulletin; data provided by the authorities; and IMF, International Financial Statistics.

The interpretation of some indicators is affected by the launch of monetary union in 1999.

Reserves and foreign liabilities refer to the Bank of Spain, both before and after EMU.

Data for June 2002 does not account for accrued profits, and is not comparable with the annual data.

APPENDIX I Fund Relations

(As of December 31, 2002)

I. Membership Status: Spain became a member of the Fund on September 15, 1958. On July 15, 1986, Spain accepted the obligations of Article VIII Sections 2, 3, and 4 of the Articles of Agreement.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements:

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VI. Projected Obligations to Fund: None

VII. Exchange Rate Arrangement:

Spain entered the final stage of European Economic and Monetary Union on January 1, 1999, at a rate of 166.386 Spanish pesetas per euro. Under the arrangement, internal exchange rates with respect to the national currencies of EMU participants were fixed to the euro on January 1, whereas the external exchange rate of the euro is market-determined.

VIII. Article IV Consultations:

The last Article IV consultation was concluded on February 1, 2002. Spain is on the standard 12-month consultation cycle.

APPENDIX II Statistical Issues

Areas for improvement include:

  • General government. The reconciliation of cash and accrual general government data is unclear. Details of these calculations would enhance monitoring at higher frequencies.

  • Territorial governments. The details and timeliness of budgets and fiscal outcomes are wanting. The importance of monitoring fiscal developments at the territorial level is heightened by recent deviations from their fiscal targets, and is essential for the Budgetary Stability Law.

  • Employment and productivity data. Two different measures of unemployment are reported by the authorities (so-called “registered” and “survey” unemployment), which vary substantially. Data on employment growth are distorted by the flow of workers from the informal to the formal labor force, which complicates the calculation of productivity growth and hence unit labor costs.

  • National Accounts. These and fiscal data have been revised in line with the 1995 version of the European System of Accounts, but pre-1995 data remain to be revised.

Spain: Core Statistical Indicators

(As of January 14, 2002)

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Central government balance is released to the press monthly, about three weeks after the end of the month, and published by the Ministry of Finance.

Spanish government debt held by nonresidents is released to the press weekly by the central bank and drawn by staff from Reuters.