RaboResearch - Economic Research

Spain: Economic Outlook 2020 and beyond

Economic Report

  • The Spanish economy is losing momentum, but continues to grow faster than many Eurozone peers
  • We expect the economy to grow by 1.5% this year and 1.2% next year, after 1.9% in 2019
  • The new left minority government has plans to increase social welfare spending
  • Less fiscal consolidation could support the economy in the short term, yet would likely come at the expense of economic growth and social benefits in the medium term
  • Especially as the government will struggle to implement policy to raise productivity growth and tackle other major economic challenges that are clouding the medium-term outlook
  • The Catalan crisis will expectedly continue to dominate the political agenda as a solution to the conflict is far away

Lower growth, with public finances still weak

The Spanish economy is losing momentum. The business cycle is substantially advanced, with limited spare capacity left. In fact, the unemployment rate (14.1% in November) has already fallen below its structural rate of close to 15% (OECD, EC). A weak global environment and increasing uncertainty related to Spain’s economic outlook are likely to further stem growth. We expect the economy to grow by around 1.5% this year and 1.2% next year. This is below last year’s 1.9%, but above the forecast growth figure for the Eurozone economy of 1% this year and 0.8% next year.

Based on provisional data, the 2019 public deficit was unchanged from 2018: at 2.5% of GDP. Over the next two years, we expect the budget balance to at best improve by a few tenths, based on the 2018 government budget currently still in place and the coalition’s program revealed end 2019. The same holds for the public debt ratio, which stands at around 97% of GDP. Which is only 4 percentage points below its peak in 2014, despite very high GDP growth rates in the past years. 

Figure 1: Growth is steadily slowing
Figure 1: Growth is steadily slowingSource: Macrobond, Rabobank, NiGEM
Figure 2: Public debt ratio falling at snail’s pace
Figure 2: Public debt ratio falling at snail’s paceSource: Macrobond, Eurostat

Growth is steadily slowing

Friday 31 January, Spain’s statistics bureau (INE) will publish the GDP growth figure for the final quarter of 2019. Based on sentiment and production and retail sales data, the economy is expected to have grown by around 0.4% compared to the third quarter, which is broadly in line with growth in the second and third quarters.

We expect growth to remain close to this rate in the coming quarters, and to slow a touch moving into 2021. Activity in the industrial sector seems to have reached a trough during the final quarter of 2019. But while some improvement is expected going forward, industrial activity is expected to remain subdued. The sector continues to face headwinds from weak global economic growth and international trade tensions. The recently signed phase 1 deal between the US and China might give some respite, but is no Walhalla. The outlook for the construction sector is also weakening as the recovery in the housing market slows. Even though the construction sector is still far from having recovered the losses endured during the crisis.

Activity in the services sector has held up well, mainly benefitting from relatively strong domestic demand. Yet some services industries are starting to feel the pain of the industrial weakness which is expected to continue for some time given the ongoing challenges industry faces. Moreover, while sentiment levels are still above their average of the past 20 years, deteriorating sentiment among consumers and services providers suggests a poorer outlook for the services sector going forward.

Figure 3: Industrial sector still contracting
Figure 3: Industrial sector still contractingSource: Macrobond, Markit
Figure 4: Slowing yet still strong jobs growth
Figure 4: Slowing yet still strong jobs growthSource: Macrobond, DG ECFIN, Rabobank calculation

Domestic demand

Meanwhile, domestic demand will continue to benefit from employment growth, real wage increases, improved private sector balances and low interest rates. Yet several factors are limiting its growth. Employment growth has been slowing and is expected to continue on this path. Furthermore, overall consumer sentiment is worsening, with consumers indicating that it is a good time to save, suggesting savings will increase at the expense of consumption. Meanwhile, private investment is hampered by deteriorating sentiment, flattening corporate income and squeezed margins on the back of rising unit labor costs and fierce international competition.

Fiscal policy is expected to be broadly neutral or slightly expansionary. While this could provide a minor boost to the economy in the short term, it will come at the expense of economic growth in the medium term when the government will need to hit the brakes to safeguard debt sustainability.

Figure 5: Private sector balances have significantly improved
Figure 5: Private sector balances have significantly improvedSource: Macrobond, BIS
Figure 6: Wage growth significantly outpaces inflation
Figure 6: Wage growth significantly outpaces inflationSource: Macrobond, Eurostat, Spanish Ministry of Economy & Business

A left-wing coalition government it is

Tuesday 7 January, the coalition of the center-left PSOE and the far-left Podemos narrowly won the investiture vote in Spain’s parliament. It is Spain’s first coalition government since the country’s return to democracy in 1975. The coalition had to depend on the support of eight parties and the abstention of two others to pass the vote. The ‘Sí’s’ only outnumbered the ‘Nó’s’ by two votes. Despite the weak majority and the varying objectives of the many parties supporting the government, the left-wing coalition is expected to be around for a while. Not least because of the fear of new elections which could very well result in a (radical) right-wing (anti-separatist) government. Yet with the right-wing opposition parties unlikely to lend much support and given the divisions between pro-government parties, the government will have a hard time dealing with Spain’s many economic challenges such as very high structural unemployment (around 14%), low to negative productivity growth, tons of bureaucracy and a rapidly ageing population. Consequently, the medium- to longer-term outlook for Spain’s economy continues to be rather bleak.

Coalición progresista

Or in plain English: a progressive coalition. That is how PSOE and UP have titled their coalition program. It is a left-wing program including a higher minimum wage, pensions and other social welfare spending. On the revenue side the government wants to lower taxes for small companies, raise taxes for the rich,  introduce a minimum tax rate for big corporations and a digital services tax. The minimum wage is projected to rise by about 30% until 2023, although the program lacks details on how to get there.  

Regarding pensions, the government intends to permanently restore the link between pensions and inflation and permanently break the link between pensions and life expectancy and the performance of the Spanish economy. These latter two measures were introduced back in 2013 to guarantee the long-term sustainability of the pension system, but have never been enforced. Changes to the system are in fact urgently needed to guarantee its sustainability in light of the rapidly ageing population.

Other important spearheads in the program are reforms in the labor market. Unlike previous rumors and claims (especially by UP), the government has no intention of entirely rolling back the reforms implemented by Rajoy in 2012 – i.e. in the midst of the debt crisis. Yet it does want to get rid of some parts of the reform. For example, it wants to limit the ability of employers to fire employees on extended sickness leave and to alter contract terms unilaterally. The government also wants to increase the importance of sectoral wage agreements over firm-specific agreements. This would make it more difficult to couple wage growth to productivity growth for example. Spain already underperforms most Eurozone peers in this respect, harming firms’ competitiveness and profitability.  

Fiscal slippage and implementation challenges

All in all, the program is likely to slow down fiscal consolidation. Prime Minister Pedro Sánchez claims he wants to comply with European budget rules, but he plans to do so by asking the European Commission for more flexibility within those rules: (flexibility worth €8 billion, i.e. about 0.7% of GDP, according to ‘el País’). This suggests that the government aims for a neutral or slightly expansionary fiscal policy, instead of a contractionary one. While domestic demand could marginally benefit from higher welfare spending in the short term, the impact of the intended minimum wage would very likely be negative. It would very likely backfire via competitiveness losses for exporting firms, lower investments and lower employment growth, since productivity growth would not be able to match such high wage growth.

Meanwhile, planned public investment in R&D and education, and better active labor market policies could benefit the economy in the medium term. However the plans are currently too vague to make an adequate impact assessment. Moreover, too little attention is being given to prepare public finances for the next downturn and the rapidly ageing population, risking harsh austerity measures during any future crisis and in the longer term to pay for the costs of ageing even in the absence of any crisis.     

Figure 7: High structural unemployment rate requires better active labor market policy
Figure 7: High structural unemployment rate requires better active labor market policySource: Macrobond, OECD
Figure 8: Rapidly ageing population requires attention
Figure 8: Rapidly ageing population requires attentionSource: Macrobond, United Nations

The never-ending Catalan story

The government is ‘supported’ by the Catalan separatist party ERC. ERC has not voted in favor of the coalition, but abstained to let the PSOE and Podemos take the stage. To get them on board, Sánchez has agreed to start negotiations over Catalonia’s future. Ultimately these negotiations should lead to an agreement Catalans can vote on. The national government will also look at a reform of the regional finance model, which is more fair and meets demands of autonomous regions to have more independence relating to fiscal policy. While dialogue could temper tensions between Catalonia and Madrid for the time being, negotiations under the previous Sánchez government have proven to be unfruitful and finding a solution will remain inherently difficult, if not impossible.

Even though ERC is the most moderate flank of the Catalan separatist movement, they still ultimately want a referendum on independence. Something all main national political parties, including the PSOE, rule out. The fact that their leader, Oriol Junqueras, will not be released from jail, despite a December ruling of the European Court of Justice in his favor, does not help the relationship between Barcelona and Madrid. In any case, the Catalan crisis will continue to dominate the public debate and political agenda. With right-wing opposition parties trying to seize every opportunity to accuse the current government of endangering Spain’s unity by cooperating with separatists.

In short

The Spanish economy is losing momentum, but continues to grow faster than many Eurozone peers. The new left minority government intends to increase social welfare spending and raise productivity growth, but plans related to the latter are still vague and implementation will expectedly fall short. More attention should be given to the unsustainable welfare system and reducing the large public debt stock.

Meanwhile, the agreed dialogue between Barcelona and Madrid could help to ease Catalan tensions to some extent, but divisions run very deep and agreement on a solution acceptable to both sides seems pretty much impossible at this time. As such, the Catalan conflict will continue to dominate the political agenda in the coming years, very likely at the expense of policy to improve Spain’s longer-term outlook. 


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