RaboResearch - Economic Research

Spain's struggle against COVID-19 hampers its economic recovery

Economic Report

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  • Spain is struggling in its fight against the coronavirus
  • Apart from health implications, this also has economic repercussions
  • After the rebound in activity in Q3, we expect very weak quarterly economic growth from Q4 until a vaccine is widely available
  • We forecast GDP to contract with 13.3% in 2020 and to grow with 5.3% in 2021
  • We expect the official unemployment rate to average 15.7% this year and 20% next year
  • Public finances have deteriorated vastly and debt to GDP is set to reach 125% this year
  • July’s agreement on the EU recovery fund has had a positive impact on bond yields
  • But given the many unknowns and expected timing, we have not incorporated the possible positive impact of actual EU recovery fund money in our growth forecast for 2020-2021, yet

The resurgence of the virus

Figure 1: Spain struggles to get the virus under control
Figure 1: Spain struggles to get the virus under controlSource: Macrobond, RaboResearch

Spain has been struggling to get the second wave of the coronavirus under control. After having suffered among the world’s worst (measured) outbreaks in spring, the number of confirmed cases again increased significantly over the summer (figure 1).
Weekly new cases have exceeded the April’s peak for some weeks now, and while hospitalizations are not following at a comparable trend, pressure on several local health systems, among which that of Madrid, is high.

Figure 2: Spain reintroduced some restrictions over summer
Figure 2: Spain reintroduced some restrictions over summerNote: The index is constructed based on the strictness of containment measures in different categories, such as workplace closing and restrictions on gatherings. The relaxation early September stems from the opening of schools. Strengthened restrictions introduced early October are not yet visible in the data.
Source: Macrobond, University of Oxford

Over the summer Spain already reimposed several previously rolled back containment measures (figure 2) and early October the government introduced further limitations to activity and movement of people in cities with specifically high infection and hospitalization rates.
Currently only Madrid matches the thresholds. The latter’s administration has implemented the rules set, yet also filed a suit in court to fight them, to “defend the rights of Madrilenians”. They furthermore accused the government of creating chaos and politicizing the health crisis. Since the start of the health crisis there have been many disputes between the left-wing central government and several regional administrations as well as with the opposition, over handling of the corona crisis. It illustrates Spain’s governance crisis, significant political polarization and the current government’s limited mandate.

Q3 will show strong growth compared to Q2

Apart from the health and political implications, the second wave also has economic repercussions. Importantly, the rapid increase in virus infections since mid-summer and subsequent quarantine measures, scared off even more tourists during part of the high season. This is especially costly for an economy in which tourism accounts for almost 15% of GDP - with more than half of the revenue coming from foreign tourist expenditure. In a broader sense, the reintroduction of several containment measures, especially those in the hospitality sector, hurts economic activity, as do altered behaviour by cautious consumers and the realization or confirmation that the virus will continue be with us for longer.

Nevertheless, the Q3 GDP figure, to be presented by the end of October, will undoubtedly show that the economy grew strongly compared to Q2 (figure 3), after the massive contraction in the first half of the year (-22% compared to end-2019, figure 4). Because despite the fact that containment measures were never completely lifted, they were less strict and hence less economically damaging in Q3 than in Q2. We think GDP grew with 10.5% q/q in Q3.

Figure 3: The economy strongly rebounded in Q3, but there is still quite some work to do
Figure 3: The economy strongly rebounded in Q3, but there is still quite some work to doSource: Macrobond, RaboResearch
Figure 4: Public consumption was the only expenditure component holding up in 20H1
Figure 4: Public consumption was the only expenditure component holding up in 20H1Source: Macrobond, RaboResearch

Limited upward potential without a vaccine

As from Q4, we expect quarterly economic growth to slow substantially and possibly flat line. This slowdown is underscored by business surveys in August and September, showing that activity expectations for the months ahead have weakened (figure 5). We think that economic activity will continue to be hampered by containment measures until a vaccine is widely available. In our baseline scenario this will be the case over the course of 2021. The subsequent removal of containment measures will pave the way for some strong quarters. But still, it will likely take time for demand to normalize and years for GDP to return to pre-crisis levels. Job losses and weakened private and public balance sheets will put a lid on growth in demand, while losses in some hard-hit sectors take time to recover. Tourists will not catch-up for all lost holidays, for example. They won’t all come twice in August 2021, because they missed their trip in August 2020. Given the importance of the sector for the economy, this slows the speed at which the overall economy can be expected to return to pre-crisis levels.

We forecast GDP to contract with 13.3% this year and to grow with 5.3% in 2021 (figure 6).

Figure 5: Weaker business’ activity expectations
Figure 5: Weaker business’ activity expectationsSource: Macrobond, RaboResearch
Figure 6: GDP will only partly recover next year
Figure 6: GDP will only partly recover next yearNote: The light blue bar is RaboResearch’s forecast
Source: Macrobond, RaboResearch

Government policy has saved jobs, but damage is still large

Since April, the government has saved jobs with government support and a ban on layoffs. Yet prior to this fiscal support, in the second half of March almost 900.000 people were let go (figure 7), i.e. about 4.5% of total workers. Moreover, policy could not prevent that many seasonal workers in the hospitality and broader tourism sector were not hired. While some employment growth was visible in tourism related sectors during summer, by the end of September employment was still 2% lower than at the same time last year. Q2 data shows that especially workers on a temporary contract have borne the brunt, with temporary contracts down 21% y/y. On top of that, some 735.000 workers (4% of total workers) were in the short-time work scheme ERTE, according to the latest data available (23 September). This means their employer has no work for them, but they are not fired either, with the government paying 70% of their salary. The government thinks –or hopes– that they will return on the payroll of their employer at some point. This seems to have happened to a large share of previous beneficiaries, as the number of people on a ERTE has substantially fallen from 3.4 million at the peak in April. Yet, we think part of the final ERTE receivers will eventually lose their job. It will take years before hard-hit sectors will have recovered their very large losses and hence before employment in these sectors can return to pre-crisis levels. Given the very high costs of ERTE (2.5% of GDP so far and still counting) and difficulty in reaching the recent agreement on its extension until 31 January, it is unlikely the government will continue to extend ERTE until all ‘ERTE jobs’ are recovered.

Employment in the construction sector still has not returned to pre-crisis levels after the housing market bust in 2008. Ideally the unemployed could find work in another sector, where they are at least as productive. But that transition is made easier in economics text books than in the real world, especially given Spain’s rather weak scores on, for example, vocational training – a weakness the government would be wise to address. In any case, the transition is likely to take years.

Bankruptcies down?

For preserving economic activity and employment, not only direct job support measures matter, but also liquidity measures that prevent firms from going bankrupt. The uptake for government guaranteed loans has been significant. This helps to explain why despite massive income losses by non-financial firms in the first half of the year (-31% y/y in Q2), far fewer firms went bankrupt than in the same period last year (figure 8). While from a macroeconomic point of view liquidity support is justified to help solvent yet temporarily illiquid firms, current data suggests insolvent firms are also being rescued at the expense of the health of the public balance sheet and longer-term economic growth. In any case, once the support measures come to an end and matured guaranteed loans cannot be rolled-over, a wave of bankruptcies should be expected.

Unemployment data ‘distorted’ by measurement issues

What this means for the unemployment rate (16.2% in August) is not clear cut. Clearly timing of the above is of essence, but it also depends on the number of people actively looking for a job: you are not counted as unemployed if you are not looking for a job. The number of job seekers has dropped dramatically during the crisis, limiting the rise in the official unemployment rate. As an example, the unemployment rate would have been 22.8% instead of 15.4% in Q2, if people willing to work but not actively seeking work would count as being unemployed. Taking all the above factors into account we expect the official unemployment rate to average 15.7% this year and 20% next year, compared to 14.1% in 2019 and the peak of 26.1% in 2013.

Figure 7: March saw largest drop in employment
Figure 7: March saw largest drop in employmentSource: Macrobond, RaboResearch
Figure 8: Bankruptcy proceedings drop in 20H1
Figure 8: Bankruptcy proceedings drop in 20H1Source: Macrobond, RaboResearch

Major deterioration of public balance sheet

The public budget deficit will reach double digits this year and we expect the debt to GDP ratio to reach 125% (figure 9), due to both fiscal support measures and the massive contraction in GDP. So far, costs of direct fiscal support measures related to the corona crisis are estimated at about EUR 45bn[1] (3.6% of 2019 GDP). On top of that, the government has deferred certain tax and mortgage payments and guarantees certain loans to businesses. In total, the government can become liable for EUR 165bn dollar worth of loans (13% of 2019 GDP). The ultimate costs for the government of the guarantee scheme will depend on the total uptake of guaranteed loans and on the share of those loans that borrowing firms cannot repay themselves. Finally, in spring, the government also approved a minimum vital income which was already on the government’s wish list prior to the COVID-crisis, with estimated annual costs of about EUR 3bn to EUR 5bn. Low interest costs on new debt - owing to ECB policy and several EU support measures – do not require immediate austerity measures to keep growth financeable (figure 10), but the government cannot totally neglect its very weak finances if it wants to keep public debt affordable in the future. The further the recovery has run, the more attention will (have to) be paid to fiscal reform, with possibly negative implications for growth.

Figure 9: The corona crisis undoes past years’ small reduction in public debt
Figure 9: The corona crisis undoes past years’ small reduction in public debtSource: Macrobond, RaboResearch
Figure 10: Bond yields are still close to all-time lows
Figure 10: Bond yields are still close to all-time lowsNote: 2020 is RaboResearch’s forecast
Source: Macrobond, RaboResearch

The impact of the EU recovery fund

In our 2020-2021 forecast we have taken note of the positive impact the ‘agreement’ on the EU recovery fund, which leaders of EU member states reached in July, seems to have had on the government’s bond yields. But the possible positive impact of actual EU recovery fund money has not yet been incorporated. There are still many unknowns such as the timing, the amount and destination within Spain, as well as what reforms Spain will implement in return. Furthermore, money is unlikely to flow before the second half of 2021, since agreement on the fund’s details is not expected before early next year. Hence the impact on 2021 growth can be expected to be limited anyhow. In the years thereafter, the fund could have a non-negligible impact on Spain’s GDP, though, both directly via the actual additional public investment and by the return on those investments in the longer term.

Furthermore, if designed and implemented in the right way, the reforms that are required in return can have a long-lasting positive impact on growth (OECD, 2019). Although it could take time before the latter gains become visible. Based on current proposals, Spain could expect to receive about EUR 72.7bn in grants (about 6% of 2019 GDP) between 2021 and 2026. To what extent it would require a higher contribution by Spain to the EU budget from 2028 depends on to what extent the EU will be able to raise its own resources in the next multiannual framework. Yet in any case, Spain is destined to be a net receiver of funds.

As soon as we have sufficient information on how much money Spain will receive, when it will receive it and how it will spend it, we will adjust our forecast if deemed necessary. In this light there is some upward potential for the growth figure of 2021.

Footnote
[1] RaboResearch calculations based on IMF data, IIF data and statements by Spain’s finance minister.

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