Spain: 2006 Article IV Consultation—Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Spain

Spain showed strong growth performance marked by robust job creation and a solid fiscal position. Executive Directors supported the National Reform Program (NRP), which focuses on improving productivity, market flexibility, and competitiveness. They commended the appreciable fiscal surplus, pension reserve fund, and the public debt reduction. They welcomed the new Budget Stability Law (BSL), appreciated the Financial Sector Assessment Program (FSAP) assessment and the monetary stance of the Bank of Spain. They emphasized the need to regain competitiveness through the implementation of structural reforms.


Spain showed strong growth performance marked by robust job creation and a solid fiscal position. Executive Directors supported the National Reform Program (NRP), which focuses on improving productivity, market flexibility, and competitiveness. They commended the appreciable fiscal surplus, pension reserve fund, and the public debt reduction. They welcomed the new Budget Stability Law (BSL), appreciated the Financial Sector Assessment Program (FSAP) assessment and the monetary stance of the Bank of Spain. They emphasized the need to regain competitiveness through the implementation of structural reforms.

I. Introduction

1. The Spanish economy is enjoying a prolonged expansion. In 2005, Spain’s economy grew by 3.4 percent and created more than 60 percent of all new jobs in the euro area. This remarkable expansion has raised income levels to the EU-25 average and reduced the unemployment rate by 12½ percentage points since 1996, even while absorbing exceptionally large immigration flows. Activity has been supported by strong domestic demand growth, which has outpaced that of GDP since mid-2002. Sustained fiscal consolidation efforts and robust growth turned a budget deficit of 5 percent of GDP in 1996 into a surplus of over 1 percent of GDP in 2005, while public indebtedness was cut from 67 to 43 percent of GDP. The past decade also witnessed an impressive expansion of the financial sector’s presence domestically and abroad—Spanish institutions’ financial assets increased from about 220 percent of GDP in 1996 to 330 percent in 2005.



(4-Q change, in percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


Spain: Domestic Demand and GDP

(4-Q change, in percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


Spain: Job Creation

(In percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

2. Growth has however become increasingly lopsided, as reflected in a widening inflation differential and rising current account deficit. Domestic demand has boomed, supported by employment and income gains; wealth effects from rising real estate and equity prices; and rapid credit expansion in the midst of negative real interest rates. Propelled by mortgage credit growth of 25 percent in 2005, household indebtedness reached over 110 percent of disposable income. While the authorities have allowed the full play of fiscal revenue stabilizers and maintained a contractionary budgetary stance for several years (albeit less so in 2005), this has been insufficient to offset very loose liquidity conditions. The inflation differential with the euro area thus reached 1¾ percentage points in 2006:Q1, and the 2005 current account deficit rose to 7½ percent of GDP—the second largest in absolute terms in the world. While Spain’s oil dependency, the weakness of its traditional export markets, and its advanced cyclical position have all played a role, the current account deterioration also reflects a steady real exchange rate appreciation and related export-market share losses. As documented in the authorities’ National Reform Program under the Lisbon Agenda, the erosion of competitiveness goes beyond cyclical factors: structural factors include lackluster productivity growth and significant rigidities in product and labor markets.


Spain: Trade Deficit and Real Effective Exchange Rate

(In percent of GDP, and index 1999Q1 = 100)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

3. While a smooth and gradual rebalancing underlies both official and staff projections, there are important risks. The main one is a continuation of the current unsustainable pace in domestic spending that is followed by pronounced adjustments in household balance sheets and real estate valuations, entailing a protracted period of depressed employment and activity. The discussions were thus centered on the role of fiscal and structural policies in forestalling such scenarios.

II. Background

4. In 2005, domestic demand growth again outstripped that of GDP and net exports increased their drag on output. Consumption and construction investment maintained a rapid pace, together contributing some 4 percentage points to growth—although exhibiting a mild deceleration over the year. In addition, the long-awaited recovery in equipment investment got underway, possibly hastened by expectations of tighter financing conditions. For its part, the drag on growth from net exports reached some 2 percentage points, as import penetration and the erosion of export market shares intensified. Housing wealth gains remained a key buttress of demand, although real house price growth decelerated further, from a peak of 15½ percent in 2003:Q2 (seasonally adjusted, q-o-q annualized) to 8¼ percent in 2006:Q1. Reflecting this pattern of demand, the expansion was concentrated in the services, construction, and energy sectors; sectors exposed to external competition, in contrast, experienced little growth.


Spain: House Prices

(Seasonally adjusted, q-o-q annualized, percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

5. High inflation persisted through 2005 and accelerated at the turn of the year, reflecting the pass-through of fuel prices and backward price indexation of wages. Comparatively high oil dependency has resulted in a significant contribution of energy and transportation items to headline inflation. But core inflation also exceeded the euro area average by a widening margin (1.6 percentage points in 2006:Q1), reflecting the continued upward price drift in the sheltered services and retail sectors. Hourly labor costs have shown a decelerating trend despite substantial increases in the employment rate and reductions in unemployment, pointing to a decline in the NAIRU—underpinned by high immigration and growing female participation. Nevertheless, wages still increased faster than the euro area average, as did unit labor costs. Price indexation clauses in collective wage contracts stand to sustain price pressures into 2006.


Hourly Labor Costs

(Total Economy, Annual Change in Percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: Eurostat.

Unit Labor Costs

(Total Economy, Annual Change in Percent)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: Bank of Spain; and European Central Bank.

6. Liquidity conditions remain expansionary. Real lending rates are negative or close to zero, and both household and corporate credit grew at over 20 percent in the year to January 2006, spearheaded by mortgages and credit to real estate developers. There is little housing equity withdrawal, and nontraditional mortgages are still relatively rare, albeit developing quickly.


Households’ Indebtedness 1/

(In percent of disposable income)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

1/ For the euro area, data through the third quarter of 2005.

Growth of Real Estate Credit

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

7. Mirroring the current account deterioration, the economy’s net external liability position exceeded 46 percent of GDP in 2005—primarily associated with increased intermediation of foreign savings by financial institutions. Since the mid-1990s, the widening external deficit has reflected a decline in the savings–investment balance of the household and nonfinancial corporate sectors, only partly offset by an improving fiscal balance.1 Credit institutions and other financial intermediaries (e.g., structured-finance vehicles), while presenting a financial surplus themselves, have met the increasing financing need of the nonfinancial private sector by issuing securities in euro-area markets. Net external borrowing by these two sectors amounted to 14 percent of GDP in 2005, mainly through mortgagebacked securities, of which Spain has become one of the largest EU issuers. In terms of gross external debt, while Spain’s liabilities have a longer maturity and a lower public component than other comparable countries, its net international liability position is larger.


Spain: Current Account Deficit, Savings, and Investment

(At current prices in percent of GDP, seasonally adjusted)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


European Securitization Issuance in 2005 by Country of Collateral

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Sources: European Securitization Forum, securitization data report, winter 2006

Financial Balances by Sector


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Note: 2005 includes data through 2005–Q3

International Comparison of International Investment Position (IIP) 1/

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Source: Net IIP is from Philip R. Lane and Gian Maria Milesi-Ferretti, “The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004,” IMF Working Paper 06/69. All other variables are from the Bank of Spain.

All data refer to September 2005, except the international investment position which corresponds to 2004.

Financing between related enterprises.

III. Report on the Discussions

8. With immediate growth prospects jointly seen as positive, the discussions focused on the role of economic policies in averting adverse scenarios stemming from accumulated imbalances and competitiveness losses and on financial sector policies in light of FSAP recommendations. Spain’s economic policies have for several years been largely in line with Fund policy advice (Box 1), and on this occasion too there was a broad convergence of views on the diagnosis and policy requirements. Nuances centered on the extent to which competitiveness losses were already a manifest concern, and consequently on the degree of urgency and ambition of the recommended response. This also reflected the authorities’ assessment of the measures’ feasibility, in light of the government’s emphasis on a consensual approach and its minority position in Parliament. Furthermore, the authorities were doubtful of the proposition that the ongoing economic expansion provided a propitious environment for reform since “good times” diminish the perceived need for change. In this setting, and with the current legislature ending in early 2008, staff attempted to impart a greater sense of policy urgency, including in its outreach activities vis-à-vis parliamentarians, trade unions, employers, regional representatives in Catalonia, and academics.

Fund Policy Recommendations and Implementation

Policies for several years have been broadly in line with Fund advice—notably in terms of a stability-oriented fiscal policy framework and structural reforms in labor and product markets. On the former, pending steps to enhance the cyclical sensitivity of the fiscal framework are consistent with Fund advice, though improvements in fiscal transparency still fall short of requirements—particularly at the subnational level, where the new Budgetary Stability Law also provides a greater degree of leeway than advised by the Fund.

The authorities’ structural reform agenda is consistent with Fund analyses and recommendations, and Spain has generally taken a liberal and open position on EU-wideissues—though it too appears prone to some protective reflexes as the internal market approaches more sensitive areas (e.g., energy). Also, labor market reform has been insufficiently bold, and that of the pension system continues to be delayed. The authorities have consistently maintained strong financial sector prudential policies, as recognized also in this year’s positive FSAP findings.

A. Outlook: A Bright Near-Term but Clouds Further Out

9. Immediate growth prospects remain upbeat. Staff and official projections broadly coincide. Growth is projected to moderate slightly to some 3.3 percent in 2006 and to 3.2 percent in 2007. A slowdown in retail sales, consumer durables, house prices, and other leading indicators all suggest a prospective domestic demand softening. On this basis, consumption and residential investment are expected to decelerate in 2006, with the housing market gradually cooling off. Business investment, while remaining high as a proportion of GDP, should plateau in response to higher capital costs. At the same time, the gathering euro-area recovery is expected to reduce the drag from the external sector. Indeed, the authorities noted that firming euro-area interest rates and strengthening external demand was the ideal combination for a rebalancing of Spanish growth. Staff agreed, though euro-area interest rates are unlikely to rise sufficiently from the Spanish economy’s standpoint. The inflation forecast for 2006 remains close to 3½ percent, well in excess of the euro area average.

10. The authorities’ Stability Program, and staff, project that external imbalances would remain large over the medium term. While the authorities envisage a continuation of the export recovery that started in the second half of 2005, the observed high elasticity of imports coupled with the projected growth in final demand point to a further steady deterioration in net exports. Increased interest payments and immigrant remittances, and the envisaged decline in EU transfers, will additionally raise the economy’s financing needs to above 8 percent of GDP by 2008. Staff stressed that a prolonged external imbalance would expose the economy to interest rate risk and other shocks and would be unsustainable over the long term.

11. The authorities expect their competitiveness-enhancing policy agenda to eventually reverse this trend, while recognizing that such a turnaround would take time to unfold. In this context, they also pointed to the role played by the intertemporal profile of saving and investment, whereby the observed increase in the current account deficit may have inter alia been brought about by a temporary excess of planned private investment with respect to aggregate savings. The current level of net external liabilities could thus be smoothed in the future through some combination of real exchange rate depreciation and a gradual moderation of domestic absorption. In principle, they noted, there would be no need for an abrupt adjustment. They also pointed out that EMU membership drastically expanded the economy’s capacity to finance external deficits—inter alia, by eliminating currency risk.


Spain: Real Effective Exchange Rate

(CPI based, indices, 1999Q1 = 100)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

12. Staff agreed, but noted that, by the same token, in the absence of sufficiently flexible product and labor markets, regaining competitiveness could entail a long and difficult process weighing on output and employment—as evidenced by some other euro area experiences.2 In this context, the main downside risks remain real estate overvaluation and associated household indebtedness. A demand retrenchment accompanied by a downward house price adjustment would negatively affect the construction sector, which accounts for 10½ percent of output and 14 percent of employment. On the positive side, FSAP and Bank of Spain analyses indicate that the financial system is well-positioned to withstand shocks of a plausible magnitude—including a hypothetical fall in real house prices of slightly over 17 percent in the first year and of 4½ percent in the subsequent year,4 a 30 percent drop in equity prices, or an abrupt depreciation of the US dollar. Nonetheless, staff remained more concerned than the authorities about the risks attendant to the current situation, and consequently argued for a more vigorous structural and countercyclical policy response. There was agreement that the solution to the productivity and related competitiveness problem lies first and foremost in structural reforms. Staff noted that these however take time, during which fiscal policy should be directed to attenuating imbalances.

Spain’s Competitiveness: What is the Evidence?

The current account position has deteriorated from an average deficit of close to 2½ percent of GDP since EU accession in 1986 to one of 7½ percent of GDP in 2005 (Panel A). This reflects primarily a widening trade deficit, but the income and current transfer balances have also deteriorated owing to larger interest payments (as net international liabilities increased), migrant remittances, and lower EU transfers. The trade deterioration, in turn, reflects the cyclical position and oil prices, but also structural competitiveness problems. In staff’s view, a range of evidence points in this direction.

Staff estimates based on a decomposition of the current account balance for the 1980–2005 period indicate that oil prices explain about 33 percent of its variation, with the cyclical position accounting for an additional 37 percent. The remaining unexplained residual, about 30 percent, has become increasingly negative (particularly since 2003) and amounted to 2½ percentage points of GDP in 2005, presumably reflecting in part underlying competitiveness losses (as well as, in part, the impact of weaker demand in Spain’s traditional export markets). These estimates are consistent with those of private sector analysts, discussed during the mission. A staff cross-country study3 showed that conjunctural variables have recently underestimated Spain’s trade deficit, also pointing to emerging structural factors. As noted in the main text, the authorities are of the view that part of the deficit could simply reflect an intertemporal saving-investment decision, whose resolution need not entail high real sector costs, and pointed also to the importance of EMU membership in mitigating risks associated with current account deficits. They also noted an encouraging pickup in recent export growth as possibly indicating a turning point in the external sector’s contribution.

Spain’s trade-weighted export market share increased until about 1998. Since then, it has stagnated, declining as from 2003 (Panel B). Import volume penetration has risen continuously (Panel C)—with the worldwide decline in import deflators causing a temporary recovery in nominal terms during 2001–03. Reflecting both lower productivity and higher labor cost growth, the manufacturing unit labor cost differential with the euro area has widened by 16 percentage points since 1995 (Panel D). As a consequence, indicators of Spain’s export margins have exhibited the weakest evolution among other large euro-area economies since 1995, albeit recovering somewhat since 2003 (Panel E). The authorities agreed that these data, though susceptible to nuanced interpretations, tend to point to the presence of a component of loss of competitiveness in explaining the current account deficit, whose extent is however difficult to determine precisely.

Real exchange rate developments also show an erosion of competitiveness (Panel F). Given the theoretical and practical difficulties associated with estimating equilibrium real exchange rates, the staff employed several methodologies to assess, in a broadly illustrative manner, the improvement in competitiveness (as measured by the real effective exchange rate) required to (a) satisfy long-term equilibrium determinants drawn from cross-country panel data analyses (net foreign assets relative to exports, commodity prices, labor productivity and production in the manufacturing sector), along the lines of the Fund’s macroeconomic balance approach; (b) achieve the trade deficit that would stabilize net external liabilities close to their current level; and (c) achieve the average trade deficit of the last 20 years. Though such methodologies have known shortcomings, with the results contingent on the assumptions and subject to large estimation errors, they all suggest appreciable competitiveness weakness (in a range of 23–30 percent). This magnitude needs however to be interpreted with considerable caution. Indeed, the authorities strongly feel that the lack of consensus around the theoretical models on which to base specifications, and the high degree of discretion in setting out the hypotheses that condition the estimation outcomes, detract considerably from the significance of such calculations. Furthermore, the analysis assumes that the current account adjustment would take place exclusively through real exchange rate depreciation. However, they note, the adjustment could also come from a gradual increase in savings.


Panel A Current Account and Trade Balance


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: Bank of Spain and INE

Panel B Trade-Weighted Market Share of Spanish Exports


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: World Economic Outlook (IMF)

Panel C Import Penetration


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: INE.

Panel D Manufacturing Unit Labor Costs


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: OECD Analytical Database; Staff Estimates (2005) in euro area.

Panel E Exports Margin Indicator 1/


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: OECD Analytical Database; INE; & EC Database.1/ Ratio of exports goods deflator to manufacturing ULC.

Panel F Real Effective Exchange Rate 1/

(1995 - 2005)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: International Financial Statistics (IMF).1/ Based on relative Consumer P rice Indices.

B. Dampening Demand—The Task of Fiscal Policy

13. Buoyant tax collections resulted in an appreciable budget surplus in 2005, but the fiscal stance was only mildly restrictive, if at all, owing to an expansion in outlays. The achievement of a fiscal surplus (1.1 percent of GDP) and further reduction in public liabilities are the result of the authorities’ successful efforts over several years to shore up support for sound public finances—a support the mission found in all of its encounters, including with the trade unions. While welcoming this achievement, staff argued that, from a cyclical standpoint, the fiscal stance in 2005 had been inadequate owing to excessive growth in public spending. Conventional cyclically adjusted balance estimates indicate a fiscal withdrawal of about a ¼ percentage point of GDP. But beyond this indicator and its related measurement difficulties, the staff’s analysis (and work by the Bank of Spain) indicate that public spending increases have a significantly larger expansionary impact on demand and the current account than the contractive impact of equivalent revenue gains (Box 3). 5 In this light, staff argued, the effective fiscal stance was expansionary in 2005, with general government non-interest spending rising by 0.3 percentage points of GDP (adjusted for one-time balance-sheet operations recorded in 2004).

Spain: Summary Fiscal Indicators

(In percent of GDP)

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The balance for 2004 excludes one-time spending of 0.7 percent of GDP.


Fiscal Developments 2004–05

(Percentage of GDP)

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Source: IGAE; and Bank of Spain.

Excluding one time debt assumption (0.7 percent of GDP) in 2004 from the railway operator (Renfe).

One time central government assumption of Andalucia’s debt (0.3 percent of GDP) in 2004.

14. The authorities were confident that another appreciable fiscal surplus was in the offing, laying the basis for a strong performance in 2007 as well. With 2006 revenues set to exceed budget projections by a wide margin (partly due to the regularization of immigrants), the authorities intended to allow the full play of automatic stabilizers, and expected another significant general government surplus, possibly above the 0.9 percent of GDP projected in the updated Stability Program. Staff, while sharing this expectation, noted that budget spending plans again implied an expansionary stance, with real expenditure outpacing real GDP growth: for example, central government consumption was budgeted to rise in real terms by 4.1 percent in 2006.


Social Security: Registered Workers (2002-06)

Annual growth rates

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

15. Staff advocated greater expenditure-based fiscal restraint. Specifically, staff saw merit in directing fiscal policy toward the goal of improving the 2006 general government surplus by at least ½ percentage point of GDP (relative to 2005), based on expenditure control, to contain demand pressures. To this end, the central government should aim to keep spending appreciably below current ceilings and safeguard the budget’s contingency fund for truly exceptional events. For their part, the regions should move to balance in 2006 and surplus by 2007—consistent with the new Budget Stability Law due to take effect that year.

16. The authorities saw only limited scope for reining in already budgeted spending. While not disputing the expansionary impact of public spending, and sharing concerns about its dynamics at the regional and local level, the authorities emphasized that the central government had remained within its expenditure ceiling in 2005 and would continue to do so. They did not however see scope for significant underspending, and pointed to the political economy difficulties of explicitly aiming for rising fiscal surpluses, a prospect that would whet spending appetites.6 The exceptional wave of immigration into Spain was furthermore seen to generate its own, warranted expenditure needs with regard, for example, to infrastructure, social services, education, and the judiciary. Furthermore, the government’s emphasis on improving productivity and raising R&D spending also entailed a public effort.

Fiscal Policy: Can it Help Attenuate Imbalances?

While only structural policies can improve competitiveness and growth on a lasting basis within EMU, the question arises of whether fiscal policy could contribute to attenuating imbalances in the short term, as reforms take hold. Staff has analyzed the effects of fiscal policy—using a structural vector autoregression model—with a particular focus on the current account and the (manufacturing ULC-based) real exchange rate. The results, set out in a Selected Issues paper, indicate that:

  • A 1 percent exogenous fall in real government expenditure in one quarter—which persists over one year—improves the current account balance by about 0.15–0.16 percentage points of GDP for one year and prompts a 0.4–0.6 percent depreciation in the real exchange rate by moderating ULC growth. The effects of the shock decline slowly after two years.

In contrast, the effects of a tax revenue shock appear statistically insignificant. This statistical result partially reflects the fact that, during the sample period, tax revenue increases tended to be followed shortly thereafter by spending increases which offset the dampening effect of higher taxes. The result is also broadly consistent with Ricardian equivalence, in which tax policy changes are countered by private agents’ forward-looking consumption-saving decisions, of which there is also some partial evidence.

Figure A.
Figure A.

Impulse Response of Current Account to 1 Percent Decrease in Government Expenditure

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Figure B.
Figure B.

Impulse Response of Real Exchange Rate to 1 Percent Decrease in Government Expenditure

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Figure C.
Figure C.

Impulse Response of Government Expenditure to 1 Percent Decrease in Government Expenditure

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Figure D.
Figure D.

Impulse Response of Gross Domestic Product to 1 Percent Decrease in Government Expenditure

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

C. Maintaining Fiscal Stability in the Medium and Long Term

17. A new Budget Stability Law (BSL), introducing greater cyclical flexibility and aiming to increase ownership and observance by the regions, is currently before Parliament. It is expected to take effect in 2007. The draft BSL (Box 4) seeks to allow the operation of automatic fiscal stabilizers by making budget targets contingent on the cyclical position, while aiming for fiscal balance over the cycle—an approach consistent with past Fund advice. Staff welcomed other positive features of the draft law. First, the new “balance over-the-cycle” target will apply to the general government with exclusion of the social security system (currently running a 1 percent of GDP surplus). In this respect, the authorities noted that it is more stringent than SGP requirements. Second, the draft law bars state bail-outs for lower government levels, a feature judged to be essential in the absence of legally binding enforcement mechanisms. Third, the new framework envisages strengthened reporting requirements to increase fiscal transparency of territorial governments, seen by all as an essential counterpart to the increased flexibility granted by the new law. While welcoming progress on this front, staff still judged the information flow to be insufficient to allow early identification of profligate fiscal behavior, elicit public censure, and stimulate corrective action.

18. The mission pointed to several features of the draft law that, in providing appreciable leeway, risked rendering “balance over-the-cycle” an elusive target.7 Staff noted three main concerns: first, the asymmetry in specifying a deficit limit in the case of low growth but not a commensurate surplus requirement in the high-growth scenario, entailing a risk of insufficiently ambitious targets in good times—such as the present. The authorities agreed that much would depend on implementation but saw drawbacks in setting a minimum surplus target for the high-growth scenario (it could become a ceiling). Second, the exclusion of part of capital spending was, in staff’s view, insufficiently precise. The increasing recourse to off-budget capital spending by regional and municipal governments was, in this regard, already a concern. The authorities felt that exclusion of certain spending reflected the high priority assigned to improving Spain’s lackluster productivity performance, and that circumvention would in any event be contained by the overall cap on such spending. Finally, staff noted that the draft BSL did not clearly specify whether, in good times, the surplus requirement would apply to the Autonomous Communities as a whole, or to each individual Community. This ambiguity could give rise to conflicting interpretations, which were evident during the mission’s discussions, and consequent implementation difficulties. The authorities recognized the ambiguity but viewed it as constructive, providing scope to address the main challenge to any fiscal framework in Spain: the need to coordinate the highly decentralized regional and municipal budgets, which encompass over 70 percent of public expenditure excluding social security.

The New Budget Stability Law

Fiscal targets. The proposal targets a fiscal balance over the cycle for the general government, excluding the social security system. To avoid the complexities of defining the cyclical position, it establishes targets for three states of the economy: a fiscal balance for normal growth (set at between 2 and 3 percent for the 2007–09 period); a small public deficit for low growth; and a surplus (of underdetermined size) for high growth. For the social security system, it envisages a separate target, set to ensure its financial sustainability.

Allocation of the targets. The low-growth deficit (up to 1 percent of GDP) is allocated predominantly (0.75 percent of GDP) at the regional government level. No indication is provided, however, about the level and allocation of the high-growth surplus.

Individual targets. Targets for each region will be determined by bilateral negotiations. If these are inconsistent with the overall target, the Ministry of Economy can set individual targets.

Excluded capital expenditure. The proposed law excludes capital (and some other) expenditure aimed at improving productivity and competitiveness, in an amount up to 0.5 percent of GDP, of which half is allocated to the regions. Thus, the total low-growth deficit for the central and territorial governments is 1.5 percent of GDP.

Enforcement. Three-year corrective plans are envisaged for any level of government that fails to reach the balance over-the-cycle target. Enforcement relies on expected increased transparency and timeliness of subnational data, and on an explicit barring of regional government bail-outs.

Details of the Proposed Budgetary Stability Law 1/

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The proposal excludes the social security system, which is envisaged to be in balance in the long-run. It also proposes to calculate percentages in terms of the relevant GDP, i.e., national (regional) GDP for the central (regional) government.

19. In sum, the authorities viewed the new fiscal framework as promoting co-responsibility in a manner that would maintain fiscal discipline while respecting the constitutional autonomy of the regions. They noted that the framework provided for an articulated system of annual negotiations, agreements, and monitoring among the central and regional governments that would ensure a greater degree of buy-in than currently prevailing. They agreed that transparency and accountability were ultimately the main enforcement mechanisms available, and intended to give priority to strengthening the role of the entities charged with ensuring these (the State Administration’s General Audit Office, IGAE, and the regional coordinating council, Consejo de Politica Fiscal y Financiera). They were inclined to leave for later consideration, while not discarding, the possibility of seeking means to obtain an independent assessment of fiscal policies of the various levels of government and of their consistency with the BSL. They also noted the recent progress in implementing some recommendations of the 2005 fiscal ROSC.

20. In parallel with the new BSL, territorial financing arrangements are also under review. A recently agreed reform of the Statute of Autonomy for Catalonia contains changes to financing arrangements, which could act as a broad blueprint for a more general reform of territorial financing. The Catalonian arrangements foresee the transfer of a higher share of taxes from the central government, alongside some greater taxing autonomy. Staff argued that the latter needed to be the key feature of the new system: a successful decentralization of competencies had to be accompanied by mechanisms that granted territorial governments significant powers to set their own taxes. The authorities agreed and indicated that the new arrangements would do so—particularly with respect to the personal income tax. They also viewed with favor forms of regional sales tax, but issues of compatibility with EU rules would need to be addressed. In contrast, they felt strongly that the corporate income tax should remain uniform throughout the nation, so as to avoid undue tax competition. Staff noted, however, that unless central government transfers were cut back, the current institutional framework provided little incentive for regional and municipal governments to use their enhanced tax powers—as evident from experience to date.

21. Healthcare provision also has an important financing dimension, currently under review—providing an opportunity for broader healthcare reform. Public spending on healthcare (a decentralized competency) has reached 6 percent of GDP and is growing rapidly. Given regional governments’ spending overruns in this area, health care-related transfers from the central government had to be increased by 0.2 percent of GDP over budgeted levels in 2005, and health appropriations raised in 2006, until a new cost-sharing arrangement between levels of government is established in 2007. The authorities expect that the new financing arrangements will provide incentives for regional budgets to contain costs and are introducing stricter controls and rationalizing procurement. Staff argued the need for a broader reform of the system, with effective cost containment likely to require forms of private participation and cost-sharing, such as user co-payments to rationalize demand. Similarly, it cautioned that commitments under a new disability law (Ley de Dependencia) be costed carefully and its beneficiaries targeted closely, so as to avoid another potential source of spending pressure.

22. The authorities recently unveiled a limited tax reform, aimed at simplifying the tax system and reducing distortions in the taxation of savings. They explained the deliberate caution exercised in reducing the tax burden as being based on concerns about the impact on current demand pressures—though, staff noted, such concerns could have been eased, and the tax reduction been larger, if accompanied by greater spending restraint. The reform—to enter into effect in 2007—reduces the marginal personal income tax rate and the number of brackets, introduces a uniform rate on savings (18 percent), and foresees a phased-in reduction of the corporate tax rate by 5 percentage points, while eliminating a range of tax deductions. Employers, however, considered the rate cut insufficient and more than offset by the elimination of deductions, a view disputed by the authorities, especially for small- and medium-sized enterprises. A generally shared positive feature of the reform is the uniform tax on savings, which was seen to enhance competition among financial instruments. There was however some concern that the reduction in tax-exempt contributions to private pension plans—which are still small and need encouragement—may send a deterring signal and heighten uncertainty about their future tax treatment. Finally, the reform did not eliminate the mortgage deduction—a long-standing staff recommendation.

23. From a longer-term perspective, the fiscal outlook is clouded by the lack of progress in the reform of pension and other age-related costs. Long-term fiscal projections prepared by the authorities and the EC’s Aging Working Group place Spain among the EU countries with the largest age-related spending increase over the next 25–50 years—this despite upward revisions in population growth reflecting current immigration trends and rather sanguine assumptions on future labor utilization and productivity. Apart from some initial reforms in 1997, the authorities have so far limited the policy response to the accumulation of social security surpluses in a special reserve fund, which has reached 3½ percent of GDP, allowing the postponement of funding shortfalls by five years. Nevertheless, the authorities agree that a definitive solution will require a reform of entitlements, but prolonged discussions with social partners have yet to come to closure. At the time of the mission, the focus was mainly on reducing early retirement schemes and, possibly, raising the minimum contribution period by a marginal amount. With social security deficits expected to arise within the next decade, staff noted that reform initiatives would need to be timely and more broad-ranging, encompassing actuarially fair incentives to prolong the effective working life, an extension of the base period to compute pensions, and a further expansion of private provision.


Projected Changes in Age-Related Expenditures in EU Member States 2004-30/50

(Percentage points of GDP)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: EC Aging Working Group.

D. Creating a More Competitive Spain—Product and Labor Market Reforms

24. The authorities have formulated an ambitious and detailed reform agenda to improve the dynamism of the economy. It encompasses the Dynamization Plan (February 2005, updated March 2006) and the National Reform Program (NRP, October 2005), which aim at increasing productivity and the employment rate. In the authorities’ analysis, per capita GDP growth has been driven in recent years by rising employment rates stemming from the incorporation into the labor force of large immigration flows and rising female participation. As these inflows wane, however, further advances in GDP per capita will require faster labor productivity growth, which is among the lowest in the OECD (Box 5). Regarding specific measures, the NRP emphasizes the government provision of public goods (infrastructure, education) and government sponsorship of activities with positive externalities (R&D, start-up companies). It places comparatively less weight, however, on enhancing competition-based incentives to the efficient allocation of resources, cost reduction, and innovation.

25. Staff agreed with the authorities’ analysis while emphasizing the central role that fostering competition and deregulating sheltered sectors would need to play in regaining competitiveness.8 These sectors are the major contributors to the widening price and cost differential with trading partners. An insufficient degree of competition and the associated pricing power—as shown by the differential evolution of markups between tradables and nontradables—are major factors behind the persistent competitiveness losses.9 Indeed, Spain has not experienced the productivity gains in distribution and services that have been the hallmark of economies where productivity accelerated in the last decade. Most observers and the mission’s interlocutors attributed the sluggish performance of the services sector to the lack of contestable markets and incentives to innovate.10


Indicator of Regulatory Restrictions in the Retail Distribution Sector


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: OECD

Indicator of Regulatory Restrictions in Product Markets


Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: OECD

26. Despite a welcome quantification of objectives and close interministerial monitoring of the plans’ progress, forward steps in some areas are hindered by political economy factors. Among early positive steps is an ongoing reform of the anti-trust system, designed to consolidate and strengthen the powers of the competition authorities and limit the executive’s capacity to overrule its decisions. Also, the authorities have announced a plan to restructure the loss-making public broadcasting company (RTVE). Still, in practice, energy, utilities, telecommunications, transportation, and various professional services remain relatively sheltered from competition. A complex area is that of retail distribution, where responsibilities lie with regional and municipal governments who, with a view to protecting local incumbents, have thwarted the entry of larger, more efficient firms through licensing, zoning, opening time, and other regulations. The authorities were cautiously hopeful that the new EU Services Directive, for which they had supported greater ambition, could offer the opportunity to review existing constraints in this area. In line with their good record in transposing EU Directives, staff encouraged them to exploit this opportunity fully. Less positively, as the EU internal market reaches more sensitive areas—particularly, in the case of Spain, energy, given its import dependence—a “national champions” reaction has arisen. The authorities have eliminated the “golden share” option to block takeovers of privatized public companies. In March 2006 the National Energy Commission (the sectoral regulator) was accorded broad powers over takeovers in the sector. This was widely seen as a move to stymie a foreign bid for a Spanish energy company, which competed with an alternative domestic offer, and the EC has opened an infringement procedure. The authorities observed that the objective of the legislation was to fill a regulatory void concerning takeover bids involving companies which carry on regulated activities, with the main change being an extension of the norm’s coverage to the target as well as the bidding company. Staff urged the authorities to refrain from using these newly granted powers in a discriminatory manner and to act in close cooperation with the EC on the matter. More generally, staff expressed concerns about the existing appointment procedures to sectoral regulatory agencies, which it did not see as fully guaranteeing their independence.

Productivity: The Trend in Spain is Mainly Plane

Like other European economies, Spain experienced significant catch-up in labor productivity through the mid-1980s but has since fallen behind. The subsequent slowdown has been more pronounced than in other countries (see table, next page): the productivity gap with respect to a 23-industrial country sample increased from 9 percent in 1985 to 30 percent in 2004 (or to 23 percent if measured at current prices).

The recent employment expansion is not the main cause of stagnant productivity. Productivity growth underperformance predates the expansion of employment and is not shared by other economies with booming labor markets. Nor can it be ascribed primarily to a low capital stock. When controlling for the capital-labor ratio, residual productivity (total factor productivity) exhibits the same decelerating pattern. (See Selected Issues paper for further details).


Labor Productivity: GDP per Hour Worked, 23 Industrial-Country Sample

(GDPs measured with purchasing parity standard-based exchange rates, 1995 prices)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


Total Factor Productivity Levels, 23 Industrial-Country Sample

(measured in purchasing parity standard-based exchange rates, 1995 prices)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Instead, most observers point to the key role of low ICT capital, R&D spending, and human capital. More deliberate government provision of public goods in these areas could improve productivity performance. Nevertheless, much of the identified deficit lies in the private sector and will require removing obstacles to innovate and invest in new activities. Barriers to competition, restrictive regulations, and labor market rigidities all militate against a more dynamic and entrepreneurial economic environment.

Spain: Sources of Growth. 2001–04 1/

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Souces: EC (AMECO database); Eurostat; OECD; GGDC Total Economy Database; and IMF staff calculations.

Indicators for the euro zone, EU-15, and sample totals are for the consolidated group (rather than simple averages for the member countries). “Demographics” is the working-age population to total population ratio; “labor utilization” is hours worked per working-age person; “employment rate” is the ratio of persons employed to working-age population; “labor productivity” is output per hour worked. GDP and capital stock are valued at 1995 prices and converted to a common purchasing parity standard (PPS) unit of account.

Positive numbers indicate a lag of the Spanish economy (Spain = 0) with respect to the reference economy. Conversely, negative numbers indicate that the indicator’s value for the Spanish economy is higher than for the reference economy. Components may not add up to totals because (i) they aggregate multiplicatively; and (ii) time averages are computed as the average of the ratios for each period, and thus, the average of the products will not generally agree with the product of the averages.

27. Although reforms implemented since the last decade are bearing fruit, most indicators still lag well behind Lisbon objectives and labor markets remain among the most rigid in the OECD. The rising employment rates of female and older workers, large immigration flows, and decline in structural and long-term unemployment are testimony to the growth-enhancing potential of increased labor market flexibility. Prolonged negotiations among social partners focused largely on how to reduce the incidence of temporary labor contracts, which account for 34 percent of total contracts (versus 5–10 percent in most other EU countries). This is possibly due in part to the employment weight of construction, tourism, and agriculture, all highly seasonal activities. However, it is increasingly recognized that the prevalence of temporary contracts mainly reflects the excessive rigidity of regular contracts—even though temporary contracts are also themselves among the most restrictive in the OECD. In addition, staff noted, the collective wage bargaining system is excessively rigid and centralized, preventing labor costs from matching productivity developments, and hindering geographical and sectoral labor mobility.


Spain: Contributions to the Growth of the Occupied Population

(Percentage points)

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


Strictness of temporary employment protection legislation

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001


Labor Market Flexibility and Temporary Employment

Citation: IMF Staff Country Reports 2006, 211; 10.5089/9781451812145.002.A001

Source: OECD; and Eurostat.

28. Agreement on a limited reform to labor contracting was reached in early May. The reform is centered on reducing the incidence of temporary contracts, both via legal provisions and fiscal incentives. A positive feature of the reform is the possibility of applying indefinite contracts with lower firing costs (contratos de fomento, introduced in 1997) to any worker currently on a temporary contract—but only during a limited period (through end-2007). At the same time, it strengthens legal provisions against consecutive temporary contracts, and introduces other limits to their use. Fundamentally, it does not address the key requirement, as seen by staff, of permanently reducing the rigidity and high dismissal costs of regular contracts.

E. Financial Sector

29. The Financial Sector Assessment Program (FSAP) found a highly dynamic and competitive financial system under strong prudential supervision and regulation (Box 6). The sector’s strengths include a high degree of financial intermediation; low intermediation margins; well-capitalized and professionally managed institutions; and a robust and well-developed prudential framework.11 Stress tests showed that banks and insurance companies would be able to withstand large adverse shocks without systemic distress. This reflects strong capitalization and risk management practices of systemically important credit institutions, and sizeable loan-loss cushions.

30. The main risks identified by the FSAP relate to rapid credit growth and to a potential downturn in the housing market, particularly if combined with an adverse macroeconomic scenario. In this connection, the authorities expressed some concern about the recent increase in nontraditional lending products (such as interest-only, very long-term, and adjustable amortization mortgages).12 While the wider range of financial instruments will eventually enhance the efficiency of financial intermediation, some of these products might test in the short term the financial sophistication of some borrowers and lenders, particularly when agents’ expectations may be based on the recent long period of record low interest rates. Also, although the average loan-to-value ratio (LTV) of bank’s portfolios was relatively low, marginal LTVs had been rising. The Bank of Spain had accordingly stepped up vigilance in these areas, including through disclosure guidelines and consumer awareness initiatives, and indicated its readiness to consider additional prudential action if necessary.

FSAP—Selected Main Recommendations

A. Macrorelevant Recommendations

  • Tighten prudential requirements for nontraditional real estate loans to discourage excessive risk-taking.

  • Adopt most conservative approaches under Basel II to contain credit institutions’ industrial participations.

B. Financial Sector Supervision

  • Strengthen the independence of financial sector supervisors by delegating more broadly the authority to issue norms and sanction violations to the respective agencies (ST 1/); separate insurance supervision from the Ministry of Economy (MT 2/).

  • Clearly maintain the state-level supervisors’ sole responsibility and powers regarding prudential supervision and regulation in the ongoing revisions of Autonomous Communities’ Statutes. ST

  • Introduce regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions regarding that company. MT

C. Issues Related to Savings Banks

  • Allow savings banks to merge freely, provided favorable ruling by the Bank of Spain on the viability of the merged institution. MT

  • Promote means to raise high-quality capital, such as cuotas participativas. MT

  • Reduce over time the public sector representation ceiling on savings banks’ boards. MT

1ST (short term), or 6–12 months.2MT (medium term), or 1–3 years.

31. Supervisory effectiveness and consistency with international best practices would require enhancing the statutory independence of financial regulators. Specifically, while no instances of undue interference were found, the FSAP recommended that authority to issue norms and to sanction violations be delegated more broadly from the Ministry of Economy and from the Council of Ministers to the respective agencies. Formal independence of the insurance regulator is particularly constrained because it is directly part of the Ministry of Economy. The authorities concurred and expressed their intention to continue reforms in this direction. Since several of the regional Statutes of Autonomy are presently being revised, staff stressed the importance that these revisions preserve the sole role of the State-level supervisors in prudential oversight of financial institutions, minimizing the potential for conflicts. The government maintained that this was the case, countering staff concerns about possible wording ambiguities and stressing that long-standing jurisprudence safeguarded the role of State-level supervisors.

32. The mission discussed avenues to strengthen the governance and market orientation of savings banks (cajas). Savings banks have been a major force in the expansion of financial services over the last decades and currently account for about one third and one half of credit institutions’ assets and deposits respectively. However, the nature of their ownership structure—which excludes private shareholders and provides for a large weight of political representation in their board of directors—requires a strong governance framework. The authorities noted with interest several staff proposals in this direction. These included reducing further the public sector representation ceiling in governing bodies; promoting means to raise high quality capital, such as the issuance of cuotas participativas13 to enhance market discipline; and removing restrictions to savings banks’ mergers.

33. The large industrial participations held by some credit institutions entail risks associated with concentration of exposures and raise potential corporate governance problems. The authorities argued that concentration was partly driven by the size of the Spanish market and they underscored that ownership stakes had focused on the relatively stable utilities sector and had been highly profitable to date. Furthermore, the higher degree of risk was reflected in more stringent prudential requirements. Nonetheless, to mitigate risks going forward, staff supported consideration by the Bank of Spain of adopting the most conservative approaches to the treatment of industrial participations under Basel II. Also, staff pointed out the possibility of conflicts of interest and informational asymmetries between credit institutions and other investors, and recommended, as a minimum, introducing regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution’s decisions regarding that company.

IV. Staff Appraisal

34. The decade-long expansion of the Spanish economy is continuing. The prolonged period of robust economic growth has raised average incomes, boosted job creation, and generated record fiscal revenues that have swung the general government balance into an appreciable surplus. This positive performance owes much to implementation of reforms since the early 1990s that opened the economy, enhanced its flexibility, and improved the macroeconomic policy framework, as well as to EMU membership and related low interest rates.

35. Macroeconomic imbalances are, however, intensifying. A record current account deficit is being driven by unsustainable domestic demand growth and widening cost and productivity differentials with trading partners, in addition to the effects of high oil prices. Buoyant demand and pricing power in sheltered markets are keeping inflation significantly above the euro-area average. Lackluster productivity growth is also weighing on competitiveness. The rising savings-investment imbalance of the nonfinancial private sector has been easily financed within EMU through the intermediation of a dynamic and efficient domestic financial system—but gross and net external liabilities have reached high levels, increasing the economy’s exposure to interest rate risk.

36. The immediate growth outlook is buoyant, but accumulated imbalances and competitiveness losses weigh on prospects further out. Growth is expected to remain strong in 2006, although decelerating toward trend over the medium term, while the external deficit remains high. A continuation of brisk domestic demand growth and further competitiveness losses risks being followed by a pronounced private sector balance-sheet consolidation, as households reduce their high indebtedness. A combination of market rigidities and weak competitiveness may lead to a prolonged period of difficult, slow-growth adjustment.

37. Averting these risks requires stepping up the policy response. Regaining competitiveness within EMU will require, first and foremost, the implementation of a bold supply-oriented reform agenda, with an emphasis on enhancing product market competition and labor market flexibility. As these reforms take hold, fiscal policy needs to contribute by reining in domestic demand—in the absence of monetary policy, it is the only countercylical tool to this end. In addition, even though public finances are currently on a sound footing, their long-term sustainability hinges on early reform of the pension and healthcare systems. The current high-growth environment offers the best opportunity to implement these policies, minimizing their potential short-term costs.

38. The government’s reform agenda to improve productivity and competitiveness merits the highest priority. Official plans are well-articulated, appropriately quantified, and are being carefully monitored. In their implementation, a greater emphasis should be placed on competition-based incentives. Liberalizing reforms that enhance contestability and create their own incentives for innovation are more effective than recourse to subsidy-based measures to promote R&D. Accordingly, a key focus must be on further deregulating sheltered sectors. Openness in all its guises has served Spain well for many years, and the recent changes to takeover procedures in the energy sector merit reconsideration. If maintained, it is essential that they be implemented in a nondiscriminatory manner, consistent with Spain’s good record in the transposition of EU directives. Furthermore, existing appointment procedures to sectoral regulatory agencies could be usefully reviewed, so as to fully guarantee their independence.

39. The labor market remains in need of further reform, the recent agreement on labor contracting notwithstanding. The response to Spain’s uncommonly high rate of temporary employment lies, as shown by earlier reforms, in permanently reducing the rigidity and high dismissal costs of regular contracts—an aspect that remains essentially untouched by the latest agreement. Employment protection legislation thus continues to remain among the most restrictive in the OECD, restraining the necessary response to rising global competitive pressures. In addition, the social partners should now undertake in earnest discussions on modifications to the collective wage bargaining system, to better reflect relative productivity developments and encourage regional mobility.

40. Excess domestic demand calls for greater expenditure-based fiscal restraint in 2006 and 2007. The 2005 general government surplus—the first since the 1970s—is a notable achievement, and one that sets Spain apart from other euro area countries—including, most notably, its larger partners. But behind this achievement, underpinned by cyclically buoyant revenues, public spending has been growing at an excessively rapid pace, adding to demand pressures. The authorities’ intention to allow the full play of automatic revenue stabilizers is welcome, but needs to be accompanied by spending restraint at all levels of government. Spending policies should be consistent with increasing the central government surplus and restoring a balanced position in regional and municipal governments in 2006, moving to a slight surplus in 2007—in keeping with the new BSL. Indeed, an exemplary implementation of the new framework in its first year of operation is crucial to its longer-term credibility

41. Spain’s highly decentralized system needs a robust budgetary framework to promote fiscal discipline at all levels of government. Planned revisions to the BSL contain a number of welcome features, including greater countercyclical flexibility; the safeguarding of social security surpluses; and the proscription of state bail-outs for other levels of government. At the same time, however, some ambiguous wording and insufficiently precise specifications in the draft law risk allowing excessive leeway and scope for circumvention, complicating the framework’s implementation—particularly in “good times” such as the present, when a move into surplus would be required at all levels of government.

42. The current review of territorial financing arrangements should aim to augment fiscal co-responsibility. To be successful, the ongoing decentralization of competencies must be accompanied by mechanisms that grant territorial governments significant powers to set their own taxes, and that create incentives to utilize such powers. This, rather than heavy reliance on the transfer of a higher share of taxes from the central government, which leaves incentives largely unchanged, should be the defining feature of the new financing system.

43. Increased fiscal transparency is the necessary counterpart to the greater flexibility granted by the revised BSL and new financing arrangements. Despite progress, including in implementing some of the 2005 fiscal ROSC recommendations, considerable scope remains for more extensive and timely publication of territorial governments’ fiscal data, in particular concerning budget execution, quasi-fiscal activities, and contingent liabilities.

44. Pension and healthcare reforms are required to ensure long-run fiscal sustainability. The onset of the rising costs of aging—larger than elsewhere, even taking into account Spain’s remarkable immigration phenomenon—is now only a decade or so away. The continued reform delays only raise the size of the measures that will eventually be needed. Reform measures will need to be broad-ranging, encompassing also an extension of the base period used to compute pensions, and the further development of private pension plans—whose tax treatment should be stable and predictable. Containing healthcare spending will also require reform measures, including a larger role for private provision and user co-payments.

45. The FSAP found a highly dynamic, well capitalized, and profitable financial system under strong supervision. The main risks are associated with the rapid growth of mortgages and a potential downturn in the housing market, particularly if combined with an adverse macroeconomic scenario, though stress tests indicate a robust resilience to shocks. The increased Bank of Spain vigilance regarding nonconventional mortgages and other rapidly growing credit vehicles is well advised. As regards the prudential supervisory framework, further consistency with international best practices calls for increased independence of the three financial sectors supervisors—most particularly that of the insurance supervisor, formally the most constrained. Strong governance of the savings banks is also key, and could be enhanced by fostering the issuance of instruments that enhance market accountability, reducing the ceiling on government-nominated board directors, and removing obstacles to savings banks’ mergers. The large industrial participations of some credit institutions can give rise to excessive exposure to equity markets and potential conflict of interests. As Basel II is introduced, it is recommended that the most restrictive interpretation regarding industrial participations be adopted. Also, clear separation should be introduced between credit institutions’ management and board directors of nonfinancial companies in which they have a significant stake.

46. The authorities are encouraged to continue raising their ODA toward the 0.7 percent of GNP UN target (from 0.29 percent in 2005) and to actively contribute, within the EU, to a significant liberalization of international trade in the Doha round, including in agriculture and other sensitive areas. Statistical data provision is appropriate for surveillance. Nevertheless, improvements in timeliness and standardization of regional fiscal data should be a priority (Appendix III).

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

Table 1.

Spain: Main Economic Indicators, 2001–07 1/

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Sources: IMF, World Economic Outlook; data provided by the authorites; and Fund staff estimates.

Real national accounts variables are computed at constant 2000 prices. Thus, they might differ from the official national accounts data which, since 2005, use a methodology based on chained-linked volume indices.

Year-on-year percentage change.

Based on national definition (i.e., the labor force is defined as people older than 16).

Excludes nonfactor services.

Calculations exclude one-off adjustment amounting to 0.7 percent of GDP in 2004.

Table 2.

Spain: Fiscal Accounts, 2001–07

(In percent of GDP)

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

Calculations exclude one-off adjustments amounting to 0.7 percent of GDP in 2004.

Table 3.

Spain: Public Sector Debt Sustainability Framework, 2001–50

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General government defined by ESA-95.

The figures for the years 2020, 2030, 2040, and 2050 are also annual changes with respect to the preceding year.

Based on the most recent long-run projections for pension and long-term care expenditure of Spain’s stability program and the aging working group (European Commission, 2005).

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.