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IMFSurvey Magazine: Interview

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Fragile Recovery In The Cards For Spain

Construction site in Saragoza, Spain, where the economy will need to move away from its past reliance on the housing sector (photo: Newscom)

ECONOMIC HEALTH CHECK

Fragile Recovery In The Cards For Spain

By Camilla Andersen

July 30, 2010

  • Recovery will be slow and fragile
  • Large-scale fiscal consolidation under way
  • Rebalancing the economy, creating new jobs is key challenge

Spain is undergoing a painful recession. Unemployment now stands at 20 percent, the fiscal deficit ended the year at more than 11 percent of GDP, and the recovery so far has been among the weakest in the European Union.

And while Spain’s banks largely stayed away from the toxic assets that caused so many problems elsewhere in the world during the global economic crisis, the bursting property bubble has raised fresh concerns about non-performing loans related to the construction sector.

The government announced an austerity package in May that included cuts to public sector pay, and has also passed measures to reform the country’s savings banks and dysfunctional labor market. Other structural reforms are under discussion, including pension reform.

In this interview, James Daniel, IMF mission chief for Spain, reflects on the findings of the IMF’s recently completed analysis of the economy.

IMF Survey online: Will the austerity plan approved by the government be enough to restore confidence and put the public finances on a sound footing?

Daniel: The measures approved by the government are bold and the deficit targets are entirely appropriate. Let’s remember that Spain’s debt ratio is low compared with many other countries in Europe. And once the 3 percent deficit target is achieved, we expect public debt to start falling. If the measures are complemented by longer-term reforms such as reform of the pension system, this will put Spain’s public finances on a sustainable path.

IMF Survey online: The Spanish government recently approved a reform of the labor market. Is it focused on the right measures and does it go far enough?

Daniel: The measures definitely go in the right direction and address the right issues. Spain’s Achilles’ heel is in many ways its labor market. If the country is to successfully adjust its economy and make the best use of its resources, the labor market has to work. And Spain’s labor market really stands out in Europe as not providing the right service to its country. Nobody can be happy with an unemployment rate of 20 percent. About a third of those who are employed are only in temporary contracts, and close to half of all Spanish youth are unable to find any jobs at all. The social cost is very high, and from an economic perspective, it is a waste of human capital.

"Let’s remember that Spain’s debt ratio is low compared with many other countries in Europe."

The IMF has emphasized two areas that need reform, namely the wage-setting process and the excessive protection of permanent employees, and these are the two major areas that the government is now addressing. We think the measures are entirely appropriate, but we would like them go further and encourage the government to take advantage of the parliamentary approval process and the review of the wage-bargaining system that is being discussed at the moment to push for more far-reaching reforms.

IMF Survey online: How do you see the broad outlook for growth and unemployment?

Daniel: Well, the bottom line is that it is going to be a long haul. On the positive side, the economy is already adjusting. Output has stabilized, the current account has been sharply reduced, and inflation is now below that in many other European Union countries.

"Spain’s Achilles’ heel is in many ways its labor market."

The high level of unemployment can also be seen as a response to the recession. What we need now, of course, is for people to be hired again. But the imbalances have built up over many years, and it will take time for them to be unwound. It’s about reallocating labor from construction to the tradable sector. It’s about bringing down the level of indebtedness of households and corporations. And it’s about bringing down the large fiscal deficit that was run up during the crisis. All this will take time and will have costs for the economy.

However, the more the government does on structural reform―for example in the labor market, and in implementing the European Union Services Directive―the faster we can expect growth to return, and the faster we can expect new jobs to be created.

IMF Survey online: Does Spain risk being trapped in a low-growth scenario?

Daniel: Spain’s competitiveness problem, although there is a gap, is not as large as for some other countries. Its exports have always done reasonably well and it has a diversified economy with a lot of potential.

What needs to happen now is that the economy as a whole has to move away from its past reliance on the housing sector and produce more tradable goods. That process is already in motion. Together with concerted and continued progress on structural reforms, especially in the labor market, we see no reason why Spain should not be able to return to good levels of growth in the medium term.

IMF Survey online: What is the current state of play in the banking sector?

Daniel: The Spanish banking system is generally sound and well supervised. That said, the risks facing the system are higher than they were, and they are unevenly distributed across banks and savings banks.

"The economy as a whole has to move away from its past reliance on the housing sector."

The banking system in Spain has always been competitive, and there is a risk that some banks have property or other assets on their books that may pose problems to their solvency going forward. The Bank of Spain has recently carried out a comprehensive analysis through stress tests that yielded―in an adverse scenario―additional recapitalization needs for 4 institutions. We believe this recapitalization is easily manageable from a macroeconomic perspective. The recent reform of the legal framework for savings banks should also be helpful in consolidating the sector.