Public Information Notice: IMF Executive Board Concludes 2004 Article IV Consultation with Spain

February 17, 2005

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2004 Article IV consultation with Spain is also available.

On February 9, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Spain.1


With growth proceeding at a steady pace of 2.6 percent during 2004, the Spanish economy has weathered the slowdown in the EU relatively well. Output growth has remained above the euro-area average, thanks to the strength of domestic demand—buoyed by private consumption and construction—while net exports have exercised a strong drag on economic growth. This pattern of growth has contributed to the maintenance of an inflation differential of about 1 percentage point vis-à-vis the euro area average. Concurrently, household indebtedness has continued rising amidst an ongoing real estate boom, with house prices experiencing double-digit increases for the sixth consecutive year. Despite a further erosion in competitiveness, overall export market shares have held up reasonably well, with, however, a continued compression of export margins. The external current account is estimated to have widened to some 4¼ percent of GDP in the first half of 2004.

A gradual, but sustained recovery is expected, with GDP growth projected at 2.7 percent in 2005—again based on the strength of domestic demand, with a continued negative contribution of net exports. Growth would thus continue to outstrip that expected for the euro area, but inflation is also projected to remain comparatively higher.

Policy conditions have been accommodative. In particular, real short-term interest rates have been negative for three years, spurring strong credit demand. The general government is estimated—excluding one-time adjustments—to have recorded a slight surplus in 2004, implying a mildly stimulatory stance. For 2005, the budget target of a
0.1 percent of GDP general government surplus implies a slightly restrictive fiscal stance. The authorities intend to modify the fiscal framework embodied in the Budgetary Stability Law to provide explicit scope for cyclical swings and increase observance by subnational governments in a highly devolved system.

The banking sector has maintained a strong financial position, helped by the favorable macroeconomic environment, the rebound of economic activity in Latin America, and vigilant prudential oversight. Rapidly rising real estate lending has heightened credit risk, but stress tests remain reassuring. A Financial Sector Assessment Program (FSAP) is scheduled for 2005.

On the structural front, earlier reforms in labor and product markets have improved the flexibility of these markets. Some long-standing issues remain however to be addressed, including notably pension reform, the wage negotiating framework, the land supply process, and competition in retail distribution.

Executive Board Assessment

They commended the authorities' skillful macroeconomic management and welcomed the economy's remarkably strong performance, reflected in the continued rapid rise in per capita incomes, vigorous job creation, and comparatively strong fiscal position. Sound policies—stemming from a well-established recognition of the benefits of fiscal discipline, wage moderation, and growth-enhancing structural reforms—underpin this performance. Directors endorsed the government's announced priorities of fiscal stability, transparency, and productivity enhancement, and welcomed the initiatives being taken in each of these areas. They looked forward to the further definition of policies in the period ahead to deal with both immediate and longer-term challenges and risks.

While short-term prospects remain favorable, Directors stressed that maintaining this positive outlook will require countering key domestic risks posed by the persisting real estate boom, rising household indebtedness, and an appreciable inflation differential with the euro area. While Directors recognized that the rise in house prices is partly driven by a number of fundamental factors, they cautioned that the longer the process continues, the greater the potential for an overshooting and an adverse fallout. At the same time, the unbalanced nature of the consumption-led growth, the prevalence of backward-looking wage indexation clauses, and the lack of sufficient competition in sheltered sectors risk prolonging inflation and further eroding competitiveness.

In the face of these risks, and given the presence of very accommodative monetary conditions for Spain, Directors stressed the importance of firm fiscal restraint. They thus welcomed the indications of a better-than-expected fiscal outcome in 2004, boosted by the strength of tax revenues and social security contributions. Directors encouraged the authorities to build on this result and pursue a better-than-budgeted surplus in 2005, by proactively containing central government spending below the budget ceiling, safeguarding the contingency fund, and fully saving the expected social security surplus. Directors also stressed the importance that regional governments—which account for a large share of expenditure—adhere firmly to their commitments to balanced budgets. While acknowledging the importance of prudent fiscal policy, some Directors noted that structural policies would be more effective in stemming inflationary pressures, given the underlying rigidities of the economy. In this connection, Directors supported the authorities' efforts to shift the composition of spending in favor of research, development, and education in order to enhance Spain's productivity and competitiveness over the medium term.

Directors highlighted the importance of a strong budgetary framework for the maintenance of Spain's hard-earned fiscal stability. They stressed that the primary objective of changes to the Budgetary Stability Law thus needed to be the promotion of greater overall fiscal discipline, with reliance on well-defined and transparent rules covering the desirable medium-term target, the methodology used to determine observance over the cycle, and the fiscal relations with subnational governments.

Directors stressed the importance of fiscal discipline at lower levels of government in Spain's highly decentralized system. In the absence of hard enforcement mechanisms for subnational governments, all available means to contain risks of fiscal laxity would need to be drawn upon. Many Directors advised that the regions should consistently aim at budget balance, avoiding a build-up in subnational debt. Directors felt that the regions could usefully adopt budgetary instruments that have proved effective at the central government level, such as an expenditure ceiling and a contingency fund. They also saw a role for increased regional revenue-raising powers and the establishment of independent agencies to assess budgetary developments and trends.

Directors noted that fiscal discipline would ultimately need to rely largely on dissuasive peer and public pressure, whose exercise requires the highest degree of fiscal transparency. They welcomed the positive assessment of the fiscal Report on the Observance of Standards and Codes (ROSC) that Spain meets, or exceeds, the Fiscal Transparency Code's standards in many areas, as well as the authorities' more recent steps to enhance transparency. However, Directors called for a significant improvement in the timeliness and publication of subnational budgetary data. Several Directors noted that such improved fiscal transparency would need to be an integral part of any changes to the Budgetary Stability Law.

Directors urged the authorities to assign higher priority to comprehensive pension reform, noting the slow progress under the Pacto de Toledo process to date. They remarked that the fiscal costs of aging, while arising comparatively later in Spain than in other EU countries, would still be considerable. While the build-up of the pension reserve fund is thus welcome, Directors stressed that such pre-funding could not by itself ensure the longer-run sustainability of social security. Reforms aimed at raising the effective retirement age and strengthening the link between contributions and benefits would also be needed. Directors noted that, if decided promptly, reform measures could be phased in gradually, avoiding the need for more difficult measures as the demographic shock nears.

In the labor market, Directors welcomed the appreciable progress in key employment and other indicators, on the heels of a series of labor market reforms. Nonetheless, Spain continues to lag significantly behind key Lisbon objectives, and Directors encouraged the authorities to take further action to narrow this gap. The ongoing social dialogue should clearly aim to promote the labor market flexibility required for the smooth absorption of Spain's large immigration flows. In this vein, Directors suggested that reducing the rigidity and costs of standard open-ended contracts is the best way to reduce the uncommonly high rate of fixed-term contracts. They also reiterated the need to reform the collective wage bargaining system to assign greater attention to relative productivity developments, and move away from indexation clauses.

In goods and services markets, Directors supported the authorities' emphasis on increased competition in various areas, including through a modernization of the Competition Law. Directors expressed concern about the continued impediments to competition in retail trade and distribution enacted by subnational authorities. Noting that such barriers have costs for the regions themselves, they urged the authorities to continue working with subnational governments on policies to make competition effective throughout Spain. Finally, Directors noted the urgent need to address fundamental problems affecting the housing market, in particular by phasing out the generous tax relief favoring home ownership, changing the legal framework that discourages rental activity, and reforming the regulations constraining the supply of developable land.

Directors welcomed the further strengthening of the banking system, boosted by the favorable economic environment and the rebound of economic activity in Latin America. They noted, however, that the continued expansion of real estate-related lending has raised vulnerabilities, and welcomed the Bank of Spain's continued vigilance and the planned conduct of a Financial Sector Assessment Program. Directors also commended Spain's commitment to counter money laundering and the financing of terrorism.

Directors encouraged the authorities to build upon the increase in Spain's official development assistance in 2004, and to progress further toward the U.N. target. In noting Spain's support for trade liberalization, Directors urged the authorities to actively promote the completion of the Doha round, inter alia by supporting the flexibility needed on agricultural issues. Directors welcomed Spain's progress in increasing energy efficiency.

Spain: Selected Economic Indicators, 2000-2005 1/








Real economy (change in percent)


Real GDP







Domestic demand







HICP (average)







Unemployment rate (in percent)







Public finances (general government; in percent of GDP) 2/


Overall balance







Primary balance







Interest rates


Money market rate







Government bond yield







Balance of payments (in percent of GDP)


Trade balance







Current account







Fund position (as of December 31, 2004)


Holdings of currency (in percent of quota)




Holdings of SDRs (in percent of allocation)




Quota (in millions of SDR)




Exchange rate


Exchange rate regime


Euro Area Member


Present rate (January 18, 2005)


US$ 1.3060 per euro


Nominal effective exchange rate (1990=100)






Real effective exchange rate (1990=100)






Sources: IMF, World Economic Outlook, Information Notice System; and IMF staff estimates.
1/ Figures for 2003-2004 are Fund staff projections.
2/ Maastricht basis.
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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