Statement by Mr. Varela, Alternate Executive Director for Spain, Ms. Garrido, Government-Provided Advisor, and Ms. Navarro, Advisor to the Executive Director, July 7, 2014

This 2014 Article IV Consultation highlights that economic growth in Spain has resumed, and unemployment is falling. Exporters are gaining market share, and the current account is in surplus for the first time in decades. Financial conditions have improved sharply, with sovereign yields at record lows. Business investment is rebounding strongly and private consumption has also started to recover owing to improved employment prospects and rising confidence. Executive Directors have welcomed the improving Spanish economy. They have stressed that labor market reform should be accompanied by product and service market liberalization to maximize the gains to growth and jobs.


This 2014 Article IV Consultation highlights that economic growth in Spain has resumed, and unemployment is falling. Exporters are gaining market share, and the current account is in surplus for the first time in decades. Financial conditions have improved sharply, with sovereign yields at record lows. Business investment is rebounding strongly and private consumption has also started to recover owing to improved employment prospects and rising confidence. Executive Directors have welcomed the improving Spanish economy. They have stressed that labor market reform should be accompanied by product and service market liberalization to maximize the gains to growth and jobs.

Thanks to the efforts of the Spanish people, the decisive policy actions by the Government and the improvement in market conditions and policies at the EU level, the Spanish economy has made a clear turn around entering into an expansionary phase since last year’s Article IV Consultations. After three quarters of growth, the recovery is gathering momentum and the significant correction of major imbalances continues. Building on the progress achieved so far, the overarching objective now is to cement the recovery making it as strong and sustainable as possible and to reduce the still too high unemployment rate. The authorities are well aware that the demanding task ahead leaves no room for complacency and remain firmly committed to maintaining the reform drive to ensure a sustainable job-rich growth for the Spanish economy.

We thank staff for the intensive and candid dialogue during the thorough mission held in Spain and the balanced report and SIPs that contain many constructive and useful recommendations, which are in line with the authorities’ goals. The authorities broadly agree with the overall strategy to address the current challenges.

Recent developments and outlook

The recovery started in the second half of 2013 and now is gaining strength driven by an improvement in confidence, better labor market performance and more conducive financial conditions. Both government and staff are forecasting a 1.2 percent growth rate in 2014, amply surpassing the expectations of a year ago (0.5 percent by the Spanish authorities, 0.0 by IMF staff). Going forward, growth is expected to gradually pick up. For 2015, the authorities estimate a 1.8 percent GDP increase in 2015, only slightly higher than staff’s 1.6 percent.

In Q1 2014, GDP accelerated to 0.4 percent qoq (0.5 yoy, 1.5 annualized) from 0.2 in Q4 2013, linking three quarters of positive growth, due to a substantial increase of domestic demand caused by a rise of private consumption and a strong expansion of equipment investment.

Even with the modest growth rates experienced so far, labor markets are starting to improve responding to the reforms introduced in 2012 and the recovery of activity. The seasonally adjusted unemployment recorded in March 2014 its largest decrease since Q3 2005, dropping 1 percent yoy, with a reduction of 354,000 people. Still, total unemployment rate continues to be unacceptably high at 25.3 percent.

Inflation reached a minimum in March 2014, as the HIPC annual rate hit -0.2, but it has since returned to moderate positive values. In June, it stood at 0.1 (0.5 percent in the euro area average). In this context, wages and labor costs continue moderate while productivity goes on increasing, albeit at a more subdued rate than in recent years. Both trends will likely persist in light of the restructuring of factors of production, the existence of idle capacity and resources, as well as changes in incentives thanks to recent deep structural reforms, thus leading to a further decline in Unit Labor Costs and improved competitiveness.

Market sentiment has significantly improved, reflecting an increased confidence in the Spanish economy and improved euro area outlook. Risk premia have remarkably declined, with spreads dropping to pre-crisis levels. Also, foreign direct investment has increased by 52 percent in 2013, for a total of almost 40 billion US dollars, making Spain the ninth recipient country of FDI in the world and the first in Europe.

The current account adjustment has been remarkable from a peak of 10 percent deficit in 2007 to a 0.8 surplus in 2013, with exports gaining quota share and tourism hitting new records. It is expected that this trend will continue, albeit at a moderate rate due to the gradual strengthening of domestic demand, while the net IIP, which was affected by negative valuation effects despite the current account surplus, enters into a declining path this year.

On medium-term growth prospects, the authorities agree with staff’s assessment of risks and the main headwinds affecting recovery. However they have more confidence on the effects of both far-reaching structural reforms already implemented and current macroeconomic policies. Furthermore, there is a significant amount of underutilized resources in the Spanish economy that give potential for sustained growth, as they are gradually reallocated to new sectors. Monetary conditions in the euro area will be important to make progress on internal devaluation deleveraging and improving financial conditions. The steps taken by the ECB go undoubtedly in the right direction.

Fiscal policy

The substantial efforts taken to improve public finances have continued. The deficit of the General Government was reduced from 10.6 to 7.1 percent of GDP in 2013 (6.6 percent of GDP, net of the one-off financial support for the recapitalization of banks). The primary deficit was reduced from 8.0 to 4.1 percent of GDP. Against the backdrop of a severe recession, the structural effort has been remarkable, 1.2 percent of GDP according to staff, while the structural primary balance was positive for the first time since 2007 with a surplus of 1.4 percent of GDP. This adds to the substantial efforts in 2012 when Spain recorded the second highest structural effort among advanced economies.

Far-reaching fiscal-structural reforms have also been implemented since 2012 to contribute to a lasting improvement of public finances. The fiscal framework has been strengthened. An independent fiscal institution (AIReF) has been created and the last steps to make it fully operational are being completed. Commercial arrears to public sector suppliers have been addressed and cleared. Mechanisms to prevent and combat tax fraud have been significantly enhanced. A comprehensive review of expenditure bases at the Central Government level has been undertaken to streamline and increase efficiency (CORA), while Regions and Local governments can adhere to these efforts. This has been complemented with significant reforms in public administration, healthcare, education and local administration, all resulting in significant structural savings.

The authorities remain firmly committed to fiscal consolidation. In view of the significant deficit reduction targeted for 2015 and to further ensure the credibility of the adjustment, the deficit reduction in 2014 has been accelerated to 5.5 percent of GDP (instead of the previous 5.8 percent). Over the medium term, fiscal consolidation will further advance in line with EU arrangements. The fiscal strategy set up in the Stability Program aims at bringing down the fiscal deficit below 3 percent of GDP in 2016 and reaching the medium-term objective (MTO) of a balanced budgetary position in structural terms in 2017, which is more stringent than required by the Stability and Growth Pact. The fiscal consolidation plan has been designed to minimize the drag on growth and facilitate job creation, while also focusing on the protection of vulnerable groups.

On the expenditure side, priority will continue to be given to expenditure restraint, focusing especially on the resizing of public administration and other current expenditures to pay due attention to the composition of the adjustment. It must also be noted that a wide range of reforms adopted during the last two years have entailed a comprehensive review of many expenditure items (pensions, healthcare, public administration, local administration, etc.) and will continue creating savings. Special attention will continue to be paid to boosting public expenditure efficiency. In this regard, a revision of public expenditures at the regional level has been recently initiated to rationalise and increase efficiency. Important steps have also been taken to reduce contingent liabilities and the electricity tariff deficit has been addressed and (as of 2014) eliminated.

As staff recognizes, the December 2013 pension reform has been an important milestone for underpinning the sustainability of the pension system. According to the latest projections, public pension expenditure is expected to decline from 10 percent of GDP in 2010 (which is below the EU average) to 9.6 percent in 2060 (EU average estimated at 12.9 percent of GDP), compared with a projected 13.7 percent of GDP in 2060 before the reform.

On the revenue side, progress has been made in the last years in the rebalancing of direct and indirect taxation in the direction of a fiscal devaluation. In 2010 and 2012, indirect taxation was significantly strengthened. The 2012 reform in VAT was implemented to increase the standard and reduced rates broadening the tax base and reducing goods subject to preferential treatment. New environmental taxes were introduced and some excise taxes increased. Reductions in social security contributions have also been introduced in 2013 and 2014, including through the temporary €100 flat rate contribution. A substantial tax reform is currently under preparation and is envisaged to be in effect in 2015. Following the report for tax reform commissioned to a Committee of Experts, the planned reform on direct taxes was unveiled on June 20, 2014 aiming at boosting economic activity, corporate competitiveness and job creation. The reform envisages, among other changes, gradual reductions in rates and a broadening of the bases for Personal Income Tax and Corporate Income Tax and further strengthening tools to fight against fraud, which is warranted to increase the revenue-GDP ratio. The planned reform also included some increases in VAT rates in line with EU legislation. The fiscal effects of the reform were already incorporated into the Stability Program, so no significant additional fiscal costs can be expected. The authorities also envisage additional reforms to certain indirect and environmental taxation in the near term.

Financial sector and credit

The financial sector program was successfully completed in January 2014. Thanks to extensive reforms and policy actions, with the support of the Euro Area partners, capital, liquidity and efficiency levels of the financial system have been bolstered and the framework of governance, regulation and supervision has been enhanced. The financial sector now has also a more efficient size and structure after undergoing a remarkable downsizing.

After the recapitalisation of parts of the banking sector, a deep cleaning up of troubled assets compounded with very demanding provisioning requirements and an accurate classification of refinanced/restructured loans, balance sheets are now sounder. Banks’ solvency position remains comfortable, with Core Tier 1 ratio reaching 11.8 percent at the end of 2013. The quality of instruments composing the capital of most banks has also improved with Tier 2 and additional Tier 1 capital instruments decreasing. The forward-looking evaluation of the solvency of Spanish Banks conducted in November 2013 by the Bank of Spain in application of a new supervisory tool confirmed the fairly comfortable solvency position of banks at an aggregated level under different macroeconomic scenarios considered.

Profitability has also improved. The Spanish banks recorded positive results in 2013 (more than €11 bn in profits), not only as a result of lower provisioning needs after the extraordinary efforts made in 2012 to meet the additional requirements imposed, but also due to the efficiency gains achieved (operating costs are now 24 percent the pre-crisis levels) and earnings resilience resulting from banks’ geographically diversified business models.

While credit to the private sector has been falling steadily since the onset of the crisis, a change in this trend is now being seen. Recent data shows that the contraction of credit to the private sector is decelerating and the flow of new credit has been growing yoy both for SMEs and households for eight and five months, respectively. However, credit recovery remains a challenge, in particular for SMEs. Against this backdrop, measures have been taken to facilitate SMEs access to finance including the development of nonbanking financing alternatives. MARF, the alternative bond market for SMEs, is now operational. The volume of ICO’s (State Finance Agency) lending program for SMEs has substantially increased. A comprehensive package is currently in the pipeline with additional measures to further ease financing to SMEs and non-financial corporations. Ongoing progress in addressing financial fragmentation in the euro area will also be helpful.

Mindful of the remaining challenges, the authorities have continued promoting measures to cement and further improve the resilience of the banking sector. Recent actions by Bank of Spain are noteworthy, notably its guidance to ensure the reclassification of doubtful credit under uniform criteria, the recommendation of a conservative dividend policy to foster capital increases, and a new supervisory tool to assess the sensitivity of Spanish banks’ solvency to shocks. These achievements and progress, together with the improved the economic outlook in Spain and the euro area, have been acknowledged by markets, as shown by the reduction of systemic risk indicators for Spain and in the gross recourse to the Eurosystem by Spanish banks, as well as by the high and rising Spanish banks’ price-to-book values compared to that of European peers. The authorities are thus confident that the Spanish financial system is well prepared for the ECB’s comprehensive assessment and to contribute to a strong economic recovery.

Corporate and personal debt management

Aware of the need to continue the deleveraging process of corporate and households, the authorities have been adopting measures to facilitate it while preserving financial stability and growth.

Recent data confirms that private deleveraging is progressing at a good pace. According to the ECB, corporate and household debt in Spain dropped 4.6 and 4.4 percentage points respectively from 2012 Q4 to 2013 Q4. In both cases, it has been the largest decline among the five largest European economies.

Following significant steps taken to reinforce the personal insolvency framework in 2013, the Government approved and implemented in 2014 a set of major changes enhancing corporate debt restructuring and insolvency frameworks. A Royal Decree Law approved in March 2014 introduced new tools to foster the restructuring process, including new types of in and out-of-court refinancing agreements and debt for equity swaps that can be used by any type of companies, including SMEs. The law on entrepreneurship of September 2013 also included specific measures to facilitate out-of-court insolvency agreements and promote a second chance.

Further to that, the authorities—in line with staff recommendations during the mission—have decided to further reinforce the corporate debt restructuring framework. The main steps, recently announced, include a rebalancing of the in-court debt restructuring process, fostering liquidation as a going concern, expanding restructuring options for SMEs, setting up a Code of Good Practices for SMEs and self-employed and creating an inter-ministerial commission to monitor debt restructuring processes and to foster institutional coordination. Once these measures are in place, it is expected that the remaining specific recommendations mentioned in the staff report, both for large firms and SMEs, will also be addressed.

Regarding a deeper involvement of public creditors in the debt restructuring process and the establishment of a new personal insolvency framework that provides for a full discharge of debts, the authorities have different views from staff on the scope and timing to implement them. They think more study is warranted on the fiscal and financial impact of those measures and on the strong payment culture that prevails in Spain (with household NPL at relatively low levels), in a context where NPLs are starting to contract and the recovery is still at an early stage.

Structural reforms

The labor market reform is proving successful so far. Labor market flexibility has substantially increased, allowing firms to better adapt wages and labor conditions to their real needs, wages are moderating and, importantly, the reform has substantially reduced the job-creating GDP growth threshold. In an unprecedented development, even with growth rates under 1 percent, employment is now being created.

The authorities remain vigilant and ready to take additional measures, if needed, but believe that the reform will continue to unfold to its full potential as past practices are transformed and inertia is overcome.

The authorities also consider that the current context calls for decisive action on activation policies. In this vein, a new Activation for Employment Strategy 2014–16 has been recently launched in close coordination with the Youth Guarantee Implementation Plan. This new strategy will include a common framework with the regions (given that execution and management is carried out at the regional level) setting common priorities, evaluations and monitoring of policies in a result-oriented manner. Other measures include a deep reform of the vocational training system, close coordination with private job placement agencies, and the creation of a Single Portal with all job vacancies at the national level. These measures are fully in line with staff’s recommendations.

The labor reform has significantly contributed to reduce duality and, at the same time, has had a positive impact on increasing permanent contracts, as recognized by the OCDE. Since 2007 to 2013 temporary employment has dropped from 31.5 percent to 23.1 percent, an 8.4 percent less.

Concerning social security contributions, reductions were introduced in 2013 for hiring young people and a temporary €100 flat rate contribution has been created in 2014 for new permanent contracts to support employment. As noted before, these measures go in the same direction as the fiscal devaluation suggestions made by staff. The later will imply savings of 75 percent in the tax wedge for firms and it will help creating more jobs, also among low-skilled workers. The Corporate Income Tax cuts contemplated in the tax reform will also help fostering investment and creating employment across the board.

The authorities have continued advancing with the implementation of their ambitious product and services structural reform agenda to foster long-term growth and competitiveness. A great number of critical measures have been adopted to enhance competition, increase productivity, improve the business environment and remove barriers to the growth of firms, in line with staff’s recommendations.

The law on the guarantee of market unity adopted in December 2013 is a major effort to improve the business environment and reduce administrative burdens. This reform tackles the fragmentation of the domestic market arising from different layers of regulation in more than 30 sectors and is expected to have significant impact on productivity and growth. The new framework also creates an open-ended process to address possible regulatory barriers that could emerge going forward. A “regional doing business indicator” prepared in collaboration with the World Bank will help monitoring and promoting good regulation across regions.

Measures have also been put in place under the law on entrepreneurship of September 2013 to reduce the cost and time of creation of companies, support their growth and internationalization, and simplify administrative burdens.

The reform of professional services and associations is in progress. A draft bill containing far-reaching liberalization measures (including strict limits on registration requirements and revision of membership fees) is expected to be adopted this year. By reinforcing competition and efficiency, this reform will result in important gains in productivity, competitiveness, growth and job potential.

In addition, the rental market reform adopted in 2013 will increase efficiency in this market and reduce the home-ownership bias, which is expected to have positive effects on labor mobility. Significant reforms have also been adopted to enhance the R&I framework, as well as in the retail market, transport, energy and telecommunications sectors.