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Elections Spain: Left beats right, now let's get back to business

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  • The centre-left PSOE has won Sunday’s elections, radical-right enters parliament
  • The radical right will not have a direct say in the next government, but likely to indirectly influence stance of all right-wing opposition parties
  • A minority government is in the cards, but not a given and negotiations will take time
  • The initial reaction in financial markets to the election results has been calm
  • The economy should not suffer much in the short run, but medium-term challenges are unlikely to be forcefully dealt with and fiscal consolidation is likely to proceed too slow

Sanchez gambled and won

The centre-left PSOE headed by outgoing Prime Minister Pedro Sanchez won Spain’s national elections on Sunday. Based on the preliminary results, the PSOE has won 28.7% of all votes and 123 seats out of 350 in Spain’s Congress of Deputies, i.e. the lower house of Parliament (figures 1 and 2). The runner up is the centre-right PP with only 16.7% of votes and 66 seats, followed by the centre-right liberal Ciudadanos with 15.9% and 57 seats and the very left Unidos Podemos with 14.3% and 42 seats. At the fifth place the relatively new radical-right Vox entered the national stage for the first time with 10.3% of all votes and 24 seats.

Figure 1: Taunted PSOE deals a blow to the right
Figure 1: Taunted PSOE deals a blow to the rightSource: El País, Rabobank
Figure 2: Workable majority possible, but not necessarily easy
Figure 2: Workable majority possible, but not necessarily easyNote: Regional: ERC, PNV, CCA-PNC, Compromís, PRC
Source: El País, Rabobank

Still, overall the left has beaten the right and the outcome of Sunday’s election should be seen as a significant victory for Mr. Sanchez, whose party gained 37 seats. Hence, it is now up to the PSOE to find sufficient support to govern. In our view, it is doable, but it won’t be plain sailing. Even if Mr. Sanchez choses to run a minority government once again (and there are voices in the party that would be in favour, such as Carmen Calvo, deputy prime minister), he will need the support of more than one party to win the investiture vote in parliament to start governing, which would require tough and probably lengthy, negotiations.

In European context

It is the first time in the post-Franco era that a far right party enters the Spanish parliament. And although Vox’ influence on policy will remain relatively contained, both parliament and society have become more fragmented and polarized in the past months. Moreover it shows that Spain is no longer one of the few EU countries that is immune to radical-right populism. That said, the rise of Vox need not be a headache for Europe and Spain’s political developments still very much differ from that in many other European countries. While Vox shares an anti-immigrant stance which is common among radical-right parties in the EU, it does not share their EU or Euroscepticism. That would simply not go down well in Spain. Moreover, one of the main reasons behind the emergence of Vox onto the national stage seems to be the Catalan independence pursuit, a unique feature related to Spain. At the same time, the strong showing for Sanchez’ PSOE bucks the European trend of falling support for moderate socialist parties. While it is partly the result of a more fragmented right than left, which -due to Spain’s electoral system- has benefitted the left, it is likely also the result of fear of a resurgence of the radical-right and Francoism. Yet we have to wait and see how the entry of Vox in the national parliament plays out. Being a relatively new party, its policy goals other than defending Spain’s traditions and union are not yet known. And for sure by entering national politics it has been given a national stage to advocate its ideas, which could lead to further polarization of Spain’s society, as we have also seen happening over the past year in Italy for example.

Reaction in financial markets has been calm

In the past few weeks financial markets have not shown to be very worried about (the potential impact of) the elections and so far markets do not seem very impressed with the results either. Spain’s IBEX has been only slightly underperforming other European stock markets (figure 3), while government bonds are actually still outperforming their peripheral peers (figure 4). Possibly, because Spain’s economy has been outperforming that of its peers for some years now, amid ever more fragmented politics and tensions. Moreover, the threat that the radical Vox would have a meaningful say in Spain’s next government has receded as the party made less of a splash than expected. Still, in our view the election outcome entails some downward risk for government finances.

Figure 3: Spain's stock market slightly underperforms Eurozone peers...
Figure 3: Spain's stock market slightly underperforms Eurozone peers...Source: Macrobond, Rabobank
Figure 4: ... But government bonds keep outperforming peripheral peers (10y yields)
Figure 4: ... But government bonds keep outperforming peripheral peers (10y yields)Source: Macrobond, Rabobank

Let the talks begin

So the left has won and it is up to Sanchez and his PSOE to lead the next government. To be precise, the only viable government options are those headed by Sanchez and his PSOE (figure 2).

In essence there are two government options on the table:  

A PSOE government with support of Podemos and regional (left-wing) parties  

Sanchez should be able to garner support from the far-left Podemos and non-separatist regional parties. Together these parties hold on to 175 seats. This would leave the PSOE 1 vote short of securing the investiture vote. As in the first round of the investiture vote, 176 supporting votes are necessary to pass the bar. If that vote fails, however, there is a second round of voting, and in this round the Yes-votes ‘simply’ need to outweigh the No-votes, while abstentions do not count. So, Sanchez would need one additional member of parliament on top of the non-separatist regional parties to vote in favour or to abstain, to win the investiture vote. This vote would have to come from the separatist Basque party or one of the two separatist Catalan parties. Given that defections from the party line in these kind of votes are highly unusual in Spanish politics, Sanchez will have to secure the support or abstention of one entire separatist party.

Podemos has already expressed its willingness to lend its (conditional) support and most regional parties share the PSOEs left-wing ideology and also supported Sanchez last year to oust Mariano Rajoy from office. Moreover, in the past weeks, Junqueras, the leader of the Catalan separatist party ERC, has moderated his tone somewhat. He has stated that a Catalan independence referendum remains a (long-term) goal, but that independence or a referendum is not necessarily a short-term prerequisite and that the dialogue between the Catalan and national government should continue. This at least gives Sanchez the opportunity to talk with ERC. A precondition for an independence referendum would definitely block that option.

That said, while possible, this scenario likely requires lengthy talks. Sanchez would have to negotiate for support with at least six parties. Furthermore, the PSOE prefers to govern a minority government with outside support of Podemos, while Podemos’ leader Iglesias is of the opinion that his party should be offered a few ministerial posts.

A PSOE government with in- or outside support of Ciudadanos

Together, the PSOE and Ciudadanos have 180 seats: an absolute majority. The parties share some economic policy ideas, for example when it comes to education, the labour market and dealing with corruption. Yet when it comes to dealing with the Catalan separatist demands they are on opposite sides of the spectrum. While the PSOE has showed willingness to talk with the separatist leaders about more autonomy and has offered financial threats, Ciudadanos, being a unionist Catalan party, prefers to counteract Catalan disobedience with firm hand and prefers to reinstate direct rule if the separatists don’t fall back in line. Prior to the elections Ciudadanos has ruled out governing with the PSOE over the issue and the relation between both parties’ leaders has soured. Furthermore, Ciudadanos’ relatively strong and the PP’s weak performance, improves Cs outlook for becoming the largest party on the right someday. Entering a government with the PSOE could hinder that objective.

All in all, a PSOE-led minority government with outside support of Podemos seems most likely at the moment. But repeat elections can certainly not be ruled out.

Economic implications visible in the long run

Like in recent years, we expect policy uncertainty to have only limited impact on economic growth this year. Moreover, policy uncertainty has not necessarily increased compared to last year. We think growth will slow a bit compared to past years to slightly above 2% this year and a bit below 2% next year. But this is not caused by the election result and Spain is on course to keep outperforming most of its Eurozone peers. The ultimate coalition outcome could have an impact on economic growth in the longer term, however, and also on the path of fiscal consolidation.

A coalition between the PSOE and Ciudadanos seems better placed to deal with Spain’s economic and fiscal challenges, such as high (structural) unemployment, low productivity growth, an ageing population (figure 5) and weak government finances, than a coalition between the PSOE and Podemos. Even when neglecting that the latter partnership would also require support of multiple other parties. While not the focus of the recent election campaign, Ciudadanos generally advocates in favour of progressive economic reforms and fiscal consolidation, while Podemos mainly sticks up for the poor and is less concerned with bringing public finances back in order. Which in fact is necessary if the Spanish government wants to be able to efficiently deal with possible future economic shocks and given its rapidly ageing population. Public debt is still close to a 100% of GDP (figure 6), the budget deficit only just dipped below 3% of GDP and the structural budget deficit, i.e. the overall deficit adjusted for the cycle and one-offs, is still larger than 3% of GDP. This implies that when economic growth slows, the budget deficit is set to rise to above 3% of GDP again.

Moreover, even if tensions between the central and Catalan government would likely be a bit less under a left-wing administration than when Ciudadanos would be actively involved, a left-wing government with support of one or more separatist parties is unlikely to solve the crisis and runs the risk of further polarization of the society. It would imply almost half of the society is not being heard and gives ammunition to the parties on the right that want to crack down on rebellious regions. Obviously this issue is not only related to the Catalan independence strive, but also to economic and fiscal policy. In addition, it would risk higher policy uncertainty over the longer term, as the risk that policy measures implemented by a PSOE-Podemos government are being reversed by a future legislation would expectedly be larger than policy measures implemented by a PSOE-Ciudadanos government, as the latter would be more balanced across the political spectrum.

Figure 5: Especially given the ageing population
Figure 5: Especially given the ageing populationSource: Macrobond, Rabobank
Figure 6: Public debt remains a challenge
Figure 6: Public debt remains a challengeSource: Macrobond, Rabobank

Domestic demand to stay strong

This year, domestic demand will be supported by employment growth, (still moderate) oil prices (figure 7) and low interest rates. Moreover, while sentiment has worsened, it is still likely to support demand (figure 8). Furthermore, fiscal policy will be expansionary as the budget plan for 2019 was voted down earlier in the year, due to which the 2018 budget was rolled-over. As such proposed tax increases in the 2019 budget have not been implemented, while part of the outgoing government’s public spending plans, such as higher public wages and pensions, has via Decree Laws. Sanchez has also raised the minimum wage by as much as 22%, which lifts certain social benefits as well. Whether the higher minimum wage has a positive impact on domestic demand via higher salary or benefit income or a negative impact via employment destruction remains to be seen, however. 

Figure 7: Wage growth outpaces inflation
Figure 7: Wage growth outpaces inflationSource: Macrobond, Rabobank
Figure 8: Sentiment worsens, but remains supportive
Figure 8: Sentiment worsens, but remains supportiveSource: Macrobond, Rabobank

Some growth moderation likely

Despite the abovementioned supportive factors, we expect economic growth to slow a bit. Exports are constrained by weaker global growth, capacity constraints in the tourism sector and easing tensions in competing tourism destinations, while domestic demand will be less boosted by pent-up demand and held back by historically low saving rates. We think that except for in the residential sector, pent-up demand has run most of its course. Combined with historically low household saving rates this makes it likely that households will start saving a bit more of their income in the coming years. At the same time, we expect employment growth to slow in line with a weaker outlook for both external and domestic demand and also because spare capacity in the labour market has significantly diminished. Capacity constraints are slowly reaching the surface. Policy to deal with the substantial skill mismatch in the labour market and other challenges, in order to lift Spain’s economic growth potential are not to be expected any time soon. Finally, next year the government will likely have to tighten its fiscal policy, to make up for the handouts this year against the backdrop of still high government debt and a large (structural) deficit.

In short

The left has beaten the right, but elections have also led to a more fragmented parliament. While the centre-left socialists headed by Sanchez are the major winners, also the radical right Vox party can claim victory. It is the first time in the post-Franco era that the radical-right enters the Spanish parliament, on the back of a strong anti-separatist rhetoric and advocating traditional Spanish Christian. We note, however, that while Vox shares an anti-immigrant stance with radical-right parties in other European countries, it does not share their anti-euro views and has mainly gained traction due to Catalan independence strive. So while perhaps no longer immune to radical-right populism, developments in Spanish politics do not quite resemble developments in several other EU countries. This has become all the more clear from the fact that the socialist party has won and will be in charge of forming a government. And in our view, they should be able to do so, although formation talks will be difficult and lengthy and repeat elections cannot be ruled out.

The economy will continue to perform well in the short term, which was also confirmed by the preliminary GDP numbers for the first quarter (+0.7% QoQ) today, but the longer term outlook is clouded. Especially if the next government will be insufficiently concerned about tackling economic challenges holding back Spain’s growth potential and reforming public finances to be prepared for future shocks and an ageing population.

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