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.
At the outset, I would like to thank the staff both for the constructive dialogue during the IMF mission to Madrid and for the excellent papers presented for the Article IV consultation with Spain. The well-written staff report provides an insightful and balanced description of the current situation of the Spanish economy and very valuable suggestions on different key issues. The selected issues paper deals with several interesting questions of policy analysis that are most relevant in the current policy debate in Spain.
The implementation of a stable and sound macroeconomic policy and a firm commitment towards structural reforms by the Spanish government, combined with wage moderation, has led to major economic achievements in the last few years in terms of growth, economic resilience, reduction of unemployment, fiscal consolidation, debt reduction and increased economic efficiency.
There are, nevertheless, several areas where Spain must continue to make progress. The government is very much aware of this and is fully committed to remain vigilant and to continue implementing an economic policy oriented to stability, the promotion of sustainable growth in the middle and long run and further liberalization of labor and product markets.
Economic performance and outlook
After growing several years at an annual rate of over 4 percent, the Spanish economy, in line with other advanced industrialized nations, entered during 2001 in a slowdown phase, with a growth rate of 2.7 percent. In 2002, the estimated expansion rate of the Spanish authorities will be around 2.0 percent, mainly due to adverse external factors and weakening domestic demand, particularly in private consumption and equipment investment.
After meeting the Stability and Growth Pact commitments in 2001, fiscal consolidation has continued. The estimated overall deficit will probably be around −0.2 percent, a figure that strikes a clear contrast to the −3.2 percent five years ago and a −7 percent in 1995. The current account continues to have a moderate deficit of 2 percent of GDP while the external sector contribution in 2002 might have been just slightly negative, at −0.1 percent.
Contrary to previous cycles, the economy has shown during 2002 strong resilience. There continues to be a positive growth differential with the EU average growth rate of around 1 percent, facilitating further progress in the process of real convergence with the most advanced EU nations. Moreover, in spite of the slowdown, the economy has continued to create employment in 2002 at a rate of 1.6 percent, to a total of 175,000 full-time jobs. Notwithstanding this, the unemployment rate is likely to increase from 10.5 to 11.4 percent, basically due to a methodological change in the labor force survey which redefines the concept of jobless, and to the incorporation of new participants in the labor force.
For 2003, the official growth rate estimate is 3 percent, driven by an increase of 3.2 percent of domestic demand and a negative net external contribution of 0.2 percent. Private consumption will be boosted by personal income tax cuts that have come into force last January. It is estimated that this cut will save taxpayers around Euro 3.6 billion in 2003, adding 0.5 percent to GDP growth, and helping create 65,000 new jobs. In addition, government consumption is projected to increase around 3 percent, approximately at the same rate as the average of the past few years.
While construction investment will continue its expansion at a similar rate as in 2002, equipment investment should strengthen substantially throughout 2003 if the recovery is confirmed and in view both of the solid corporate earnings of the past few years and the prevailing low real interest rates.
In any event, the official growth estimate of 3 percent for 2003, somewhat higher than the staff’s estimate of 2.4 percent, is predicated on the evolution of the world economy and particularly on the performance of the U.S. and the largest European countries, as well as on the uncertainties surrounding the political arena and its potential consequences on the oil prices.
There are also some domestic downside risks, as indicated by the staff. However, our Spanish authorities remain confident that there is a low probability that these risks could materialize. Household indebtedness, which is close to the EU average of 80 percent of gross disposable income, is within manageable limits, particularly given the current monetary conditions which are not expected to undergo drastic changes in the foreseeable future. Likewise, an abrupt development in the real estate market is highly unlikely. If anything, there might be a few price corrections, most probably in the form of a decline in real terms, but housing demand continues to be quite strong. Finally, both direct and indirect effects of the economic evolution of Latin America have had a negligible impact on the Spanish economy. Trade with that region is rather small and the investment share of companies operating in LA is also very low. The staff points to a possible effect on consumer and business confidence through the equity values of companies that have invested in LA. We believe this effect should be very small if not nil, given the overall evolution of the Spanish stock exchange that has followed or even outperformed other major financial markets in Europe and the U.S.
Inflation wages and competitiveness
Inflation has accelerated during 2002, particularly since August, reaching last December a 12-month rate of 4.0 percent. However, the average inflation for 2002 will be around 3.5 percent, with an estimated differential with the Euro area of 1.5 percentage points. In the opinion of the Spanish authorities, the acceleration of inflation in 2002 is explained by several one-off factors. First of all, the indirect tax increase enacted at the beginning of 2002, that could have contributed a 0.4 percent to the CPI increase. Secondly, a methodological change on CPI statistical calculations that has affected a number of items of personal consumption. This factor could explain an additional 0.2 percent. Finally, the introduction of the Euro might have had a slightly stronger effect in Spain than in the rest of the Euro zone, due to the fixed exchange rate with the peseta and the likely rounding-off effect, contributing to the price rise probably somewhat over 0.2 percent. Oil price increases have also had an impact, as well as the adverse weather that has affected certain agricultural products.
Given the temporary nature of these one-off factors, the inflation rate is expected to come back to a more subdued level in 2003. In this regard, the evolution of food prices has shown already a substantial improvement, particularly in December, pointing to that direction.
Regarding the inflation differential with the Euro zone, apart from the apparently temporary widening undergone in 2002, the main question is whether such differential could be attributed to benign or equilibrating factors, or on the contrary, it is caused by excess of demand or supply-side rigidities. We fully agree with the staff conclusion that more research is needed to reach a definite conclusion on the underlying causes of the persistent inflation differential with the Euro area. The staff recognizes that the inflation differential attributed to benign causes varies between ¼ and 1 percentage point. Being the average differential inflation of about 1 percent in the period 1992–2002, the Spanish authorities believe that it is basically responding to equilibrating factors: the Balassa-Samuelson effect and a change in the demand of services, as a result of increases in income. The National Accounting Institute is introducing some methodological changes in the calculation of GDP as well as some statistical improvements to measure productivity that might substantially affect the empirical studies around the Balassa-Samuelson effect.
Nevertheless, there is no room for complacency. The authorities have a strong commitment towards eliminating any source of supply-side rigidities. The staff suggests that competition in the service sector should be improved, particularly among small retailers and local markets. Further to the measures that are commented under “Structural reforms” later on, the government has taken careful note of this opinion and has started to carefully study the functioning of distribution channels and its possible role in creating inflation pressures.
As regards wage moderation, it has been a relevant factor underlying the good performance of the Spanish economy in recent years, and it is highly likely that it will continue to be so in the future. The average wage increase in 2002 was 3.1 percent. The collective negotiation agreement for 2003 is about to be signed by the social partners reiterating the same basic sound principles that prevailed in 2002. Available data on productivity is not consistent with the overall economic performance. This inconsistency is fundamentally explained by the gradual absorption of the excess of supply in the labor market, the intense creation of employment, particularly on services and construction, which are sectors with low productivity levels, and probably accounting practices that need to be revised. However, indirect measures, such as the quota share with the main trade partners, show that competitiveness of Spanish products is maintained. From 1996 to 2002 the overall Spanish export quota to the Euro area remains at 8 percent. The disaggregated data with the main partners, Germany, France, Italy, the U.K. and Portugal, confirms this trend.
Role and scope of fiscal policy
The government believes that the main role of fiscal policy is to support long-term growth by creating a stable and predictable macroeconomic framework through a firm commitment to budget discipline. Following that guideline, fiscal policy in Spain is conducted within a framework based on three pillars:
- Firstly, the adherence and strict compliance with the Stability and Growth Pact (SGP) at the European level.
- Secondly, the internal Budgetary Stability Law (BSL) enacted in January 2002, that will start to be implemented in the 2003 budget. This law is based on four principles of fiscal policy: transparency, fiscal responsibility, limits on central government spending growth, and fiscal discipline. It obliges each branch of the government to be in balance or surplus, except under extraordinary circumstances.
- Thirdly, the Financing Arrangement with the Autonomous Communities (regional governments) that extends to these entities the responsibility on fiscal consolidation while providing for their revenue sufficiency.
Within this framework of strict and predictable fiscal rules, there is no much room for the use of fiscal policy in a proactive way, nor is it desirable. However, there is some scope to remain sensible to economic fluctuations in the short run. In case of a slowdown, fiscal policy could be allowed to react through the operation of the automatic stabilizers, without jeopardizing the principle of budget soundness. Moreover, both revenues and expenditures should be used to increase economic efficiency and to support appropriate decisions by economic agents on savings, investments and employment. Finally, in cases of extraordinary need, the flexibility embedded in the BSL can be used provided that a plan to return to a balanced position is submitted.
While supporting this framework, the staff suggests in its report that the implementation of fiscal policy under the BSL should be sufficiently flexible in order to be more responsive to changes in economic activity. Additionally, the selected issues paper provides some evidence of the positive impact of fiscal policy in economic activity.
The Spanish government appreciates these constructive comments. But, while agreeing that is necessary to take into account the position of the economy in the business cycle when setting the fiscal policy stance, the authorities emphasize that it is very important to continue implementing strictly the SGP and the BSL at the moment in Spain for the following reasons:
- The BSL will start to be implemented in 2003. It is necessary to demonstrate a firm commitment to it in order to strengthen fiscal credibility. Although there has been a drastic change in the public acceptance of the new role of fiscal policy, it is still a relative recent phenomenon in Spain that must be consolidated further.
- The fiscal austerity process in Spain, started in 1997, shows that fiscal retrenchment can have positive effects on activity, mainly through a crowding in of private investment.
- Finally, as shown by the current cycle, it is highly likely—as well as desirable—that in the new setting of macroeconomic policies within the EU, output volatility will diminish and consequently the need for an alleged proactive fiscal policy.
All in all, our Spanish authorities agree with staff on the need to remain vigilant of the evolution of the cycle and also on the strategy of building a small fiscal surplus in future years, not only to create a buffer for responding to economic fluctuations, but also to be better prepared for future contingencies such as the demographic shock. In this vein, the Stability Program of Spain contemplates a fiscal surplus of 0.2 percent starting in 2005–2006.
Fiscal stance and policy mix
For 2003, the government has decided to continue implementing a neutral fiscal policy in full compliance with the SGP and the BSL, that combined with the current monetary policy—the “very easy monetary conditions” in the staff’s words—will produce an overall expansionary effect. This policy mix should provide some support in the current process of real convergence with other European nations, while contributing to the overall macroeconomic stability in the Euro area. In line with this, the 2003 budget contemplates a zero nominal deficit, though the low growth scenario of 2.0 percent included in the Stability Program foresees a −0.4 percent nominal deficit. According to our Spanish authorities’ output gap methodology, this nominal deficit will still be compatible with a basically constant structural balance with respect to 2002 (estimated to be at 0.3 percent).
Staff views differ in that with a lower growth rate of 2.4 percent, there will be a structural surplus in 2003 of 0.6 percent, and hence, a withdrawal of fiscal impulse of 0.3 percent. In any event, we agree with the staff opinion that even in the case that the final balance target is achieved, under the less optimistic scenario of 2.0 percent growth, an eventual fiscal withdrawal will not be problematic at all when combined with the current stance of monetary policy.
On the revenue side, the objective is to increase the efficiency of taxation and to incentivate employment and household savings and investment. To this end, a second step of the personal income tax reform started in January 2003, contemplating an across-the-board reduction in taxes specially benefiting the lowest income groups and lighter taxations of salary income via larger reductions for earned income, as well as several incentives to increase labor market participation. On the expenditure side, the objective is to continue to raise the economy’s stock of physical human and technological capital, giving priority to public investment in infrastructure and research.
In paragraph 19, the staff makes three suggestions to improve monitoring and fiscal transparency. Regarding the execution of regional budgets, it should be noted that following the BSL, in 2003 all these regional entities have agreed to comply with the zero deficit rule and to eliminate slippages produced in 2002. The BSL contains different measures to penalize noncompliance through shared responsibility on possible financial implications, peer pressure through the Council of Financial and Fiscal Policy, the authorization by the central government of any new credit or debt issues by the regional governments, and the need to have a plan to return to a balanced fiscal position in case of a deficit. On the information about the execution of regional budgets, besides the compulsory reports to their own Parliaments and accounting tribunals, a new framework will be established to provide and share information among the autonomous communities and central government in compliance with the BSL.
With regard to the public investment by public entities outside the general government, it should be stated that it is a normal budgetary practice in full compliance with the Eurostat regulations. There is full and transparent information on the activity of these public entities, that is included in the annual budget. Definite data is published after the debate in the Parliament and three reports are prepared annually on the execution of the budget including all public entities.
Finally, on the estimation of revenues in the 2003 budget, the government believes that it has been designed appropriately with due regard to the uncertainties in the international economy. The calculation has been consistent with the baseline macroeconomic scenario of the Stability Program and with due consideration of the reform of the personal income tax. It should be taken into account that the outcome of this reform is subject to considerable uncertainty at this stage, particularly the calculation of the positive impact on revenues stemming from the expansion of the tax base brought about by the economic recovery and the effects of the reform itself.
Demographic shock
As mentioned, the quality and sustainability of public finances is a pivotal feature of the government’s economic policy. The strategy in this regard rests on the firm commitment to budgetary stability and the ensuing public debt reduction, and a set of policy measures in response to the challenge of population aging. These measures are the reform of the public pension system; the development of a second and a third pillar of pensions; the strict control and streamlining of health spending; and finally, steps to increase labor market participation.
Different measures are being implemented to reform the public pension system, which is seen as a gradual but ongoing process, based on the consensus of the affected parties. The process started with the Parliament commission called “Toledo Pact” created in 1995, that meets periodically. Recent measures include the Law on Measures to Establish a Phased and Flexible Retirement System approved in 2002, which sets up incentives for employers and workers in support of remaining active for a longer time; measures to fight fraud within the system, and the establishment of a Reserve Fund that by 2002 had already reached 1 percent of GDP, the target set for 2004. Negotiations have started with the social partners to establish a closer relationship between contributions and benefits by lengthening the period of social contributions to get access to a pension.
We welcome the debt sustainability analysis made by staff while noting that it offers a very sound and robust image of the Spanish fiscal accounts. It should be stressed, however, that this debt sustainability analysis is based on passive projections as if there were neither further changes in the budget balance or in the demographic trends, nor new measures to reform or supplement the public pension system, when in fact further measures are expected.
Financial sector
The government agrees with the staff that the Spanish financial sector is very strong and it enjoys high ratios of capitalization, solvency, efficiency and profitability, with very low levels of NPL and cautious provisioning. This situation is reinforced by close and prudent supervision.
The staff confirms the resilience of those Spanish banks that have invested in Latin America. While welcoming this conclusion, we note that only two major banks out of 369 existing financial institutions in Spain have developed a consistent investment pattern in LA, though they account for an important share of the financial activity in Spain (26 percent of deposits and 30 percent of loans). Their FDI exposure in LA amounts to US$19.8 billion, with 90 percent concentrated in the three countries with investment grade (Mexico, Chile and Puerto Rico) and Brazil. Cross-border risk is US$16.8 billion, with 84 percent centered in Mexico (46 percent), Argentina (14 percent), and Chile and Brazil (both with 12 percent).
The BIS data includes FDI, cross-border risk and local claims. It is important to distinguish between local claims nominated in local currencies, and international claims—FDI plus cross-border risk—as they have a totally different economic and financial meaning. The former implies a much smaller risk since there is no transfer risk and it is placed in subsidiaries. The latter, which accounts for US$40 billion out of a total of US$157 billion, is the most relevant variable to measure the cross-border exposure. The international claims of Spanish banks in LA account for a 16 percent of total, substantially below the 22 percent of U.S. claims, and close to the German position of 12.9 percent. Therefore, the real risk for the Spanish banks is substantially lower than the one conveyed in Box 3. Also, it is clear that vulnerability to liquidity pressures stemming from their foreign subsidiaries is small, and it seems highly unlikely that it may have any consequence on the ratings even under very stressful circumstances. We will welcome if staff could clarify its views on this issue.
The Spanish banks have fully provisioned all direct investment in Argentina, including book value and goodwill pending of amortization. Most of their cross-border risk has also been provisioned. As for the rest of investments in the region, the goodwill has been amortized at an accelerated schedule accounting to roughly 50 percent at the end of last year.
We agree with staff that the only effect of developments in LA on the two Spanish banks has been a reduction of profits and changes in their equity valuation that we believe is temporary. Their solvency, capitalization, overall profitability and efficiency have not been affected. Figure 5 shows the evolution of quotations relative to European and U.S. banks. We think they should be compared with other banks of similar characteristics, large international banks with which they would show a rather similar performance.
On internal credit, total financing by non-financial corporations has slowed down in 2002 (with year-to-year growth rates of 18.1 percent, 14.6 percent and 14 percent in the first three quarters), but it continues to increase strongly. Financing to households has hovered around 14 percent without decelerating. It is clear that there are no signs of any risk of internal credit rationing.
Labor markets
During 2002 the government has made further efforts to increase flexibility and to improve the performance of the labor market, which are summarized in the staff report. It should be noted that the measures to phase out the agricultural subsidies to agricultural workers in Andalucía and Extremadura have been completed. Moreover, in line with the staff proposal, the resources of the public employment services have been substantially increased in the 2003 budget, particularly to hire more personnel, and additional steps are being taken to increase their efficiency.
The government has been actively promoting changes in the collective bargaining system. However, this is a task mainly for the social partners, as noted by staff, and it should be based on a broad consensus. The government is incentivating this process but further dialogue is needed. Regarding the safeguard clauses, they are deeply entrenched in the bargaining practices and it will very difficult to remove them, although probably they will loose significance as the Spanish inflation converges with the EU average. In the meanwhile, it should be recognized that they have contributed to moderate wage demands in the past. The so-called "ultra actividad” is an additional element of rigidity in the bargaining process. We agree with staff that a more flexible approach should be granted in order to enlarge the scope of the negotiations, but again, changing this aspect is very much in the hands of the social partners rather than in the government’s.
Structural reforms
Increasing the liberalization and competitiveness of the product markets is a top priority for Spain. During 2002, additional efforts have been made to advance in the structural reforms front. While holding the EU Presidency last year, Spain set structural reforms as one of the priorities, resulting in the reinforcement of the Lisbon Strategy at the Barcelona European Council. Internally, the government has continued with the ongoing process of implementation of the structural reforms package launched in June 2000. Additionally new legislative initiatives have been started to improve the entrepreneurial environment and competition policy.
The focus of liberalization in 2002 has been network industries in recognition of their strategic role in determining the competitiveness of the Spanish economy. In telecommunications, a series of measures have been taken to improve the conditions for interconnection with the incumbents’ lines, to favor a general reduction of tariffs for local loop access services, and to reform public procurement procedures to attract as many operators as possible. In the energy sector the government has set up the framework to ensure full liberalization of electricity consumption, and gas supply starting in January 2003. Liberalization efforts have resulted in lower prices and increased number of operators in these network industries.
The staff points to the existence of some competition restricting practices arising from initiatives by the regions in retail trade and distribution. The government, which is responsible for setting the general legal framework, is taking steps to address this problem. Firstly, it has set a number of compulsory minimum requirements to gradually liberalize opening hours. Secondly, the Competition Tribunal will prepare a report on the possible existence of obstacles to effective competition on commercial distribution stemming from legal measures taken by the regions. The final aim will be to reach a pact with the regions to guarantee full competition in this sector.
The autonomy and independence of the Competition Tribunal has been strengthened by transforming it into an autonomous institution and increasing its budget. Also, the regions will be able to create their own institutions to foster competition, which will bring more resources and closer scrutiny to undesired market practices. We do not think that this step will put at risk the coherence of national competition policy, if sufficient coordination among different bodies at central and regional levels is established, as contemplated in the law. Further to the creation of the Council for the Defense for Competition mentioned by staff, the administrative procedures are unified and set at the national level. Also, the central institution, the Competition Tribunal, can participate in any of the procedures opened by the tribunals at the regional level.
On entrepreneurial activity, the New Enterprise Law, which will facilitate the creation of new companies by simplifying registration formalities and accounting procedures, has already been approved by Congress and submitted to the Senate. Additionally, a new bankruptcy law is in the pipeline. This law will update and unify current legislation and will introduce the possibility of partial sale of viable parts of the company, as well as changes in the penal responsibility of the entrepreneur. Regarding corporate governance, the government has asked a special commission of experts (Comisión Aldama) to report on measures to improve governance issues. The report was published this past January and puts the accent on several transparency measures, which are being studied by the government to translate them into possible policy measures.
Other issues
Spain is strongly committed to fighting against money laundering and combating the financing of terrorism. Spain is an FATF member and has played a proactive role on AML/CFT issues providing third countries with technical assistance on this area. The government has already submitted to Congress a new legislation on capital movements and anti-money laundering issues, which provides a more clear framework by refining previous legislations to include already assumed EU compromises. The new law also typifies more clearly the information requirements and omission sanctions on capital movements. Additionally a new comprehensive legislation on AML-CFT is in the process of approval. Spain supports the success of the Doha round and is committed to a further liberalization of trade with least developed countries as a key instrument in promoting sustained economic development. Trade negotiations will be carried out within the framework of the Common Commercial Policy. Concerning the Common Agricultural Policy, Spain maintains an open position to discuss and to make progress in the reform process initiated within the EU.
Regarding statistical issues, new measures will improve National Accounts and data dissemination on territorial governments. The National Statistics Institute (INE) has reviewed its National Accounts system to improve their reliability and comparability. The new series will use as base the year 2000 and will be gradually published between 2003 (series since 1995) and 2004 (series since 1980). The Budgetary Stability Law contemplates a public information center, that will provide information on the indebtedness of territorial governments in order to monitor their compliance with the law.
Finally, with regard to the share of loans in Spain’s ODA, it should be noted their decreased participation from 15 percent in 2000 to 9.2 percent in 2002. The proportion of conventional concessional loans is even lower, 6.4 percent in 2002, while the weight of the microcredits has risen recently to 2.8 percent of the total, which is seen by DAC and recipient countries as a positive development.