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Eurozone (debt) crisis: Country Profile Spain

Economic Comment

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To the Eurzone (debt) crisis overview page 

  • The build-up of large private sector imbalances related to a housing boom was the prime cause of the crisis in Spain. Before the crisis, public debt was low and the government posted fiscal surpluses
  • Spain has rather successfully reformed its banks and economy, but the crisis leaves scars in the form of high unemployment and public debt

Diagnosis

In Spain, the build-up of large private sector imbalances related to a housing boom was the prime cause of the crisis. The rapid increase of public debt was the consequence of the severe banking crisis and recession. In fact, public debt was low and the government posted fiscal surpluses just prior to the crisis. 

In the pre-crisis years, cheap access to foreign capital due to euro accession fuelled a huge housing bubble in Spain. Foreign capital was not allocated to high yielding investment, but used to finance construction activity. Banks, in particular regional savings banks, lent enthusiastically. Meanwhile, the savings rate fell and Spain’s competiveness eroded due to rapid wage increases (and wage moderation in Germany). As a result, the current account deficit increased to a dramatic 9.8% of GDP in 2007.  Spain entered the crisis with a budget surplus (2% of GDP in 2007) and modest public debt (36% of GDP). However, the huge current account deficit, bad lending by its banks and an oversupply of housing left Spain very vulnerable when the Great Recession started. The sharp fall of government revenues and required public rescues of banks led to a strong deterioration of public finances. After Greece ran into trouble in 2010, Spain was hit by contagion. Investors also started to worry about Spain’s ability to service its public debt. Financial market unrest was fuelled even more by the proposal of Merkel and Sarkozy of end 2010 to accompany future financial assistance from the European Stability Mechanism with debt restructurings. Talks about and the actual private debt restructuring in Greece in 2011/2012 had the same effect.

Crisis response

In the end, the crisis response consisted of the (promise of) external assistance, austerity and reform. Spain received a EUR 100bn ESM program in June 2012 to recapitalise its banking sector, but in the end used ‘only’ EUR 41.3bn. Just like in the other countries, Mario Draghi’s July 2012 “whatever it takes” promise and the subsequent announcement of Outright Monetary Transactions by the ECB finally removed bond yield stress. In return for the financial assistance for its banks provided by the Troika, Spain implemented severe austerity measures. As a result, private sector deleveraging was matched by public sector deleveraging. Consequently, Spanish unemployment significantly increased as did the number of corporate defaults. Spain has rather successfully reformed its banking sector and economy. In recent years, external (cost) competiveness has improved and exports have increased strongly. Together with import contraction this helped  to improve the current account balance. This year Spain is expected to be one of the fastest growing eurozone members. However, (external) indebtedness and unemployment remain very high.

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