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Spain and the IMF
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The IMF Executive Board on March 16, 1998 concluded the 1998 Article IV consultation1 with Spain.
Economic activity has been increasingly buoyant, with a strong recovery in 1997 following a modest slowdown in late 1995 and early 1996. Output, which grew by 3.4 percent in 1997, has been supported by a solid increase in exports, equipment investment, and, most recently, consumption. A favorable competitive position has stimulated export growth, while declining interest rates, rising disposable incomes, and increased consumer confidence have boosted domestic demand. These developments have been helped by auspicious conditions, but are mainly the result of economic policies aimed squarely at making Spain a founding member of the European Monetary Union.
The recovery has been accompanied by a marked decline in inflation and robust employment creation. Inflation fell steadily, from about 5 percent in 1994 to 2 percent in 1997, marking the attainment of nominal convergence with European partners. Employment grew by 2.8 percent per annum in 1995-97, reflecting the strong growth of services, a shift from public works to housing construction, and a marked increase in part-time work, following steps to facilitate these arrangements in 1994. This has resulted in a rapid decline in unemployment from its peak in 1994, although, at 20.3 percent in the fourth quarter of 1997, it has remained the highest in the EU. Unemployment continues to be concentrated in the young and unskilled population.
The external current account continued its trend improvement and posted a surplus of ½ of a percent of GDP in 1997. Although imports have risen with the cyclical upswing, this has been more than compensated by the rapid expansion of exports and tourism receipts. The favorable current account performance, accompanied by capital account surpluses, led the Bank of Spain’s reserves to be reconstituted to levels prevailing prior to 1992, while maintaining the exchange rate within a narrow margin of its central parity.
Fiscal consolidation has been firmly aimed at fulfilling the requirements to qualify for EMU participation from the outset. Solid policy implementation in 1996 and 1997, propitious cyclical conditions, and a falling interest bill reduced the general government deficit from 6.6 percent of GDP in 1995 to 2.6 percent in 1997. On a cyclically adjusted basis, the improvement of 1996–97 amounted to 3.3 percent of GDP. This has led to a reversal of the debt dynamics, with the debt-to-GDP ratio declining from 70 percent at end-1996 to 68.3 percent at end-1997. The adjustment strategy has been to rely on expenditure reductions, with some significant structural changes but also policies of a belt-tightening nature, including a freeze in public sector wages and significant cuts in public investment.
In line with the medium-term objectives of the convergence program, the 1998 budget envisages a deficit of 2.4 percent of GDP. The higher revenues derived from the economic upturn will allow for a reduction in the fiscal deficit and an increase in social spending on education, health, and active labor market policies. The budget also perseveres with prudent policies on wages and employment. However, if the envisaged deficit of 2.4 percent of GDP is not revised downwards, the 1998 budget will not improve Spain’s structural fiscal imbalance.
After its independence in 1994 and adoption of an inflation-targeting framework in 1995, the Bank of Spain geared monetary policy to the attainment of price convergence with core European countries by 1997. The bank met its objective fully. It pursued a tight monetary policy at the beginning and, once inflation was on a declining trend and there were no threats to the stability of the peseta in the ERM, it reduced its intervention rate cautiously. In the 12 months up to May 1997, the bank successively cut the reference 10-day repurchase rate by about 2 percentage points. Subsequently, the easing in monetary conditions came through dollar and sterling appreciation, but following the presentation of the 1998 budget to parliament, the Bank of Spain resumed cuts in the repurchase rate. It narrowed the repo differential vis-à-vis Germany to 120 basis points, while the peseta remained somewhat above its central parity. Bond yields continued their downward trend and fell by 160 basis points during the past year, bringing the long-term differential vis-à-vis German rates to historic lows now below 20 basis points.
The most significant recent advances in the structural agenda have been an ambitious privatization program, which yielded revenues of 2 percent of GDP in 1997, and a labor market reform that broadened the definition of fair dismissals and introduced a new type of labor contract with lower dismissal costs. In the first six months of application of the reform, the number of permanent contracts signed amounted to 480,000 (of which 330,000 were of the new type), compared with 160,000 over the same period in 1996.
Executive Board Assessment
Directors commended the authorities for the pursuit of sound macroeconomic policies that had brought Spain to the threshold of EMU. These policies had contributed to strong and broadly-based growth, full convergence of inflation to European averages, a decline in unemployment, a strong external position, and a significant narrowing of interest rate differentials vis-à-vis Germany. Against the backdrop of continued favorable growth prospects for 1998, Directors observed that the key challenge facing the authorities was to preserve and extend the recent economic gains, and particularly to sustain the high rate at which the economy created jobs in 1996–97. They encouraged the authorities to strengthen the pace of structural reform, given that in monetary union the labor and product markets would have a major shock-absorber role.
Directors complimented the Bank of Spain on its conduct of monetary policy, noting that the inflation-targeting framework that the bank had followed while keeping a close eye on the exchange rate had contributed to reducing inflation and long-term interest rates, and had helped lay the basis for the upturn in domestic demand. While recognizing that the scope for an independent monetary policy was waning rapidly, Directors suggested that the Bank of Spain be cautious regarding the reduction in official interest rates. This would lessen inflationary risks, yet still be consistent with a gradual and orderly convergence of the peseta to the rate at which it would be locked into the euro. A few Directors questioned whether, in light of the convergence of long-term interest rates, a lowering of short-term rates would have a significant impact on the economy.
Directors praised the firm implementation of fiscal policy in 1997. Most Directors noted, however, that although recent price and wage indicators augured well for meeting the inflation target in 1998, risks of wage pressures remained over a longer horizon. Thus, they stressed the need for fiscal policy to provide some restraint in the current economic upswing, thereby helping maintain Spain’s very favorable competitive position. From that standpoint, and also to reduce the debt-to-GDP ratio, continuing the pace of fiscal consolidation was both desirable and feasible, beginning already in 1998. Accordingly, Directors welcomed the authorities’ commitment to devote additional cyclical revenues to reducing the deficit, and a few speakers called for a downward revision in the deficit target of 2.4 percent of GDP. Beyond 1998, Directors viewed fiscal balance as the appropriate medium-term fiscal target for Spain, and some Directors believed that achieving that objective by 2000 would be appropriate.
On the structural side, Directors commended the authorities for their rapid privatization program, and welcomed the measures enacted to improve expenditure control. In their view, continued success in the latter sphere was closely linked to the observance of budgetary targets by regional governments; accordingly, the political agreement between the central government and the regions needed to be strengthened by establishing mechanisms to enforce it. Directors emphasized the importance of reforms to health care policy, public administration, and, over the longer term, pensions. On health care, some speakers advised undertaking a comprehensive cost containment policy that went beyond current efforts on drug expenditures.
Directors welcomed the government’s intention to introduce a tax reform to reduce personal income tax rates and improve the efficiency of the tax. They advised the government to begin the implementation of the reform in a revenue-neutral manner, by postponing a reduction in revenues until expenditure cuts had made the reduction in taxes compatible with a balanced budget in the medium term.
There was consensus that reducing unemployment was Spain’s most pressing policy challenge. In this regard, Directors considered that the labor market reform of May 1997 was an important step toward reducing dismissal costs, and thus increasing employment. They were pleased by early indications that permanent employment contracts were rising as a proportion of the total, and welcomed the improved industrial relations climate since the reform. They noted, however, that dismissal costs remained much higher in Spain than in other European countries. Directors therefore encouraged the authorities to persevere with reforms to reduce dismissal costs further, and to extend the policy effort to other areas where rigidities remained, such as the wage bargaining scheme and the system that superimposed unemployment benefits and dismissal payments. Directors also called for an improvement in labor statistics.
To maintain Spain’s favorable competitive position at the start of EMU, Directors stressed the importance of complementing wage moderation with efficiency-enhancing structural reforms, including measures in the areas of retail trade, availability of land for urbanization, and full liberalization of the rental market.
|Spain: Selected Economic Indicators|
|Real economy (change in percent)|
|CPI (end period)||4.3||4.3||3.2||2.0||2.3|
|Unemployment (in percent)||24.2||22.9||22.2||20.8||19.7|
|Public finance (in percent of GDP)|
|Central goverment balance||-5.1||-5.5||-3.4||-2.1||-1.9|
|General government balance3||-6.3||-6.6||-4.4||-2.6||-2.4|
|General government debt3||62.6||65.3||69.8||68.3||66.9|
|Money (end-year, percent change)|
|Broad money (ALP)||8.2||9.2||6.5||3.6||...|
|Interest rates (year average)|
|Three-month interbank rate||7.9||8.9||7.5||5.4||...|
|Ten-year government bond rate||10.0||11.3||8.7||6.4||...|
|Balance of payments (in percent of GDP)|
|Current account balance||-1.4||0.2||0.3||0.5||0.3|
|Reserves (US$ billions)||44.5||38.2||61.8||72.5||...|
|Fund position (SDR billions, December 31, 1997)|
|Holdings of currency||0.5|
|Holdings of SDRs||0.4|
|Exchange rate regime||member of the European monetary system|
|Present rate||Ptas 155.2 to US$1|
|Nominal effective rate (1990= 100)||80.8||80.3||80.9||77.2||...|
|Real effective rate (1990= 100)||86.3||87.5||89.3||85.2||...|
Sources: Data provided by the Spanish authorities; and IMF staff estimates.
1IMF staff projections.
2In percent of GDP.
1Under 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 directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT