RaboResearch - Economic Research

Spain: Strong economic growth masks risks related to political instability

Country Report


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  • The short-term economic outlook is strong
  • But, continued reform progress and fiscal consolidation are necessary to improve debt sustainability and the weak external position
  • Political instability weakens the reform outlook and the prospect for fiscal consolidation 

Strengths (+) and weaknesses (-)

(+) Political stability at the national level and large reforms in recent history

Spain has a history of relatively stable governments, which benefits policy making in periods of economic unrest. The economy will benefit from large-scale reforms during the crisis years. That said, the rise of two new parties in last year’s election could harm political stability going forward.

(+) Access to European financial support measures

The ECBs promise to do “whatever it takes”, the existence of the Outright Monetary Transactions framework and quantitative easing by the ECB help to lower Spain’s government bond yields, despite the country’s large debt stock, and lowers the risks related to Spain’s large external liabilities.

(-) Banking sector

Despite substantial strengthening of bank balance sheets in recent years, crisis-related (real estate) legacies remain large. The NPL ratio is still high, as is the amount of foreclosed real estate assets on bank balance sheets and the ratio of forborne loans, for both the value is uncertain. 

(-) Large (external) liabilities and low growth potential

Private and public debt are large and the net international investment position (NIIP) is very negative (-87% of GDP). The high import content of domestic and foreign demand; the relatively small global export market share; and rather low export-to-GDP ratio, hamper improvement of the NIIP. 

Key developments

1. Strong economic recovery, but labour market remains weak

In 2015, Spain was the second-fastest growing economy of the eurozone. The economy grew with 3.2% (figure 1). House prices increased by 1.7% and employment by 3%. Especially retail trade posted significant growth and employment gains. Yet despite the strong growth figures, the economy is still some 4% smaller than prior to the crisis and house prices are 35% lower than at the pre-crisis peak. Moreover, 20.4% of the labour force is still unemployed, while another 9% is underemployed, i.e. works less hours than preferred. New jobs are mostly low paid and on a part-time and temporary basis. Besides, long-term and youth unemployment continue to be extremely elevated at 10.8% and a massive 46.4% respectively (end 2015). Looking forward, economic and employment growth are expected to slow a bit, but to remain strong at around 2.5% in 2016. Unemployment will expectedly fall further to about 19% by end-2016.

Figure 1: Strong GDP volume growth
Figure 1: Strong GDP volume growthSource: Rabobank, Macrobond
Figure 2: Labour market still in dire states
Figure 2: Labour market still in dire statesSource: Macrobond

2. Private debt decreases, public debt stabilises, external position improves

Strong economic growth led to a substantial reduction of private debt. Total private sector debt fell to 176% of GDP, from 190% a year earlier (figure 3). Still, private debt remains well above ratios that literature deems negative for growth (100% of GDP) and those seen at euro entry. Private debt is expected to decrease further this year. Strong growth and an improvement of the public budget balance helped stabilise the public debt ratio in 2015 (99% of GDP). The budget balance improved from -5.9% of GDP in 2014 to -5.2% in 2015, but missed its target (-4.2% of GDP) for the eight consecutive year. Especially autonomous regions, but also the central government were to blame. Public debt is expected to remain at or near its current ratio in the coming two years. Despite increased domestic and thus import demand, the current account balance improved to 1.4% in 2015, from 1% in 2014. The improvement mainly resulted from lower import prices and debt service cost due to lower interest rates. In order to significantly reduce external vulnerability, multiple years of large current account surpluses are still necessary, as Spain’s net international investment position is extremely negative (-87% of GDP in 2014). Firm policy measures are necessary to lower demand elasticity of imports and increase export growth in order to make recent current account improvements structural. Based on current elasticities and fundamentals, the IMF has estimated that GDP growth higher than 2.5% could trigger a weakening of the current account.

Figure 3: Private debt falls, but remains high
Figure 3: Private debt falls, but remains highSource: Rabobank, Macrobond
Figure 4: Current account improves
Figure 4: Current account improvesSource: Macrobond 

3. Political instability has increased after national and regional Catalonian elections

The national elections of December 2015 have not yet delivered a new government. The elections have put an end to Spain’s post-Franco two-party system, as two new parties gained significant support: the radical Podemos at the (far) left and the liberal Ciudadanos at the centre right. Given its policy agenda, significant power in a future government for Podemos would raise concerns over public debt sustainability. Political instability has not yet derailed Spain’s impressive recovery, but the longer it takes, the higher the risk that spending decisions are postponed. Moreover, it worsens the outlook for necessary reforms to enhance competitiveness, turn the downward productivity trend and tackle high (structural) unemployment. Parties have until 2 May to form a new government. If they do not succeed, new elections will have to be called. New elections are not expected to significantly alter the situation. As far as Catalonia is concerned, the victory of the Separatists in September 2015’s election has added fuel on the discussion with Madrid over more autonomy/ independence. But no material agreement will be reached before a new central government is installed. The longer it takes for a solution to be found, the longer uncertainty weights on investment decisions. Ultimately, we expect Catalonia to remain part of Spain with more budgetary autonomy.

Factsheet of Spain
Factsheet of SpainSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

After the introduction of the euro, the relatively closed and services-oriented Spanish economy experienced a rapid deterioration of its current account balance. The dominant reason for this deterioration was a rise of imports, which was partly due to a construction boom during those years. The burst of the real estate bubble in 2008 led to a severe economic and banking sector crisis. And public debt rose rapidly from a low level. Increased worries on public debt sustainability and the solvency of Spanish banks led to a large outflow of foreign capital. An ESM-rescue package of EUR 40bn was necessary in 2012 to support Spain’s weak banks. As a condition to the package, Spain has implemented several structural reforms, especially in the banking sector and the labour market. These reforms will enhance its long-term growth potential. Nevertheless, more needs to be done to increase its low growth potential (around 1.5%), in order to improve debt sustainability and the very negative net international investment position (-87%, 2014). Part of the significant improvement in the current account in recent years is cyclical; while higher export growth is hampered by the small size of firms, low share of exports with high technological content, and low (labour) productivity. That said, currently, risks related to Spain’s weak external position are mitigated by the low interest environment, a relatively large share of  liabilities other than fixed income, and a favourable maturity structure of external debt. Substantial political autonomy of the 17 regions within Spain harms the country’s competitiveness as regulatory differences lead to a fragmented internal market. It also harms the effectiveness of nationwide reforms and toughens prudent fiscal policymaking. The latter results from the fact that multiple regions often tend to deviate from their fiscal target, set by the central government.

Economic indicators of Spain
Economic indicators of SpainSource: EIU

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