## cr17319 ## Source details **Canonical URL:** [cr17319](https://www.imf.org/-/media/files/publications/cr/2017/cr17319.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17319.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17319.pdf.json) --- ### Executive Board Assessment - Directors welcomed Spain’s continued strong and balanced growth and healthy job creation, noting the contribution of past structural reforms to competitiveness, flexibility, and resilience. - Observed persistent structural weaknesses and vulnerabilities, including high unemployment and lagging productivity relative to EU peers, and vulnerable public and private balance sheets. - Recommended policy directions: - Gradual fiscal tightening. - Preserve and deepen structural reforms to reduce structural unemployment, strengthen the business environment and competition, and make the financial sector more resilient in line with recommendations in the Financial Sector Stability Assessment (FSSA). - Fiscal policy guidance: - Maintain the current pace of adjustment until structural balance is reached. - Emphasize revenue-side measures: gradually reduce the number of goods and services that qualify for reduced VAT rates, reduce tax system inefficiencies, and raise environmental taxes, while adequately shielding vulnerable groups. - Apply the expenditure rule and increase expenditure efficiency. - Fully implement ongoing pension reforms and publicly disclose reform tradeoffs to support retirement planning. - Labor market guidance: - Adopt a holistic approach including improvements in the quality of education and training. - Use well-designed and targeted active labor market policies and enhanced Public Employment Services to help low-skilled youth and the long-term unemployed return to work. - Further reduce labor market segmentation. - Structural and competition reforms: - Accelerate competition-enhancing reforms: fully implement the Market Unity Law, liberalize professional services, ease access to equity financing for startups, and make public R&D spending more efficient. - Financial sector guidance: - Accelerate bank balance sheet cleanup, including ambitious NPL reduction. - Raise high-quality capital and reduce operating costs to improve profitability and resilience. - Rigorously monitor interest rate and bond market risks; focus on contagion risk within the financial system and cross-border spillovers. - Expand the macroprudential toolkit; establish a systemic risk council to augment risk oversight, policy coordination, and crisis prevention. ### Key issues and context - Recovery status and drivers: - Spain in fourth year of expansion; GDP, consumption, and non-construction investment rebounded close to pre-crisis levels. - Structural shift from construction to services; construction contribution about 6 percent of gross value added (post-crisis). - Drivers: wage moderation, labor market reforms, banking sector reforms, low oil prices, ECB monetary easing, and fiscal relaxation in 2015–16. - Remaining challenges: - High structural unemployment relative to Europe. - Much post-crisis growth in lower-skill, lower-productivity sectors. - Public sector debt around 100 percent of GDP. - High level of non-performing loans (NPLs) in parts of the financial sector. ### Policy priorities and recommendations (staff highlights) - Fiscal: - Rebuild buffers and create fiscal space; rely more on indirect taxes. - Fully implement ongoing pension reforms and increase disclosure of tradeoffs. - Labor market: - Targeted, coordinated, and focused ALMPs to reduce long-term disenfranchisement of low-skilled and long-term unemployed workers. - Further steps to reduce labor market duality. - Structural reforms: - Shift toward higher value added sectors; reduce within-sector inefficiencies. - Implement Market Unity Law fully, remove size-related requirements, ease access to equity financing for startups, and improve public R&D efficiency. - Financial sector: - Complete crisis legacy clean-up: address NPLs, capital, privatization of state-owned banks, medium-term bank funding, operations of the asset management company, the credit cooperative sector, and supervision and resolution frameworks. ### Financial sector findings and recommendations - Key findings: - NPLs: 8.4 percent of total loans at end-June 2017; NPLs remain especially elevated for some sectors. - Private sector deleveraging reduced the debt-to-GDP ratio by 70 percentage points from its pre-crisis peak to end-2016. - Banking system profitability is higher than the euro area average but declined and remains challenged by low interest rates, high legacy problem assets, and continued excess capacity. - Systemic interconnections rising with cross-sectoral and cross-border claims picking up. - FSSA: significant progress in strengthening banking sector soundness, but remaining weaknesses and legacy issues persist. - Recommended actions: - Accelerate bank balance sheet cleanup and ambitious NPL reduction. - Increase high-quality capital and reduce operating costs. - Monitor interest rate and bond market risks and contagion risk across the financial system. - Expand macroprudential toolkit and consider establishing a systemic risk council. - Address privatization of state-owned banks, medium-term bank funding, operations of the asset management company, the credit cooperative sector, and supervision and resolution frameworks. ### Growth, demand composition, and inflation (selected) - Growth: - Growth reached 3.2 percent in 2016 and 3.1 percent y-o-y in first half of 2017. - Consumption, investment, and net exports all made positive contributions. - Inflation: - Core inflation: 0.8 percent in 2016; 1.2 percent (y-o-y) in June. - Headline inflation: jumped to 3 percent (y-o-y) in January and February; declined to 1.5 percent (y-o-y) in July. - Labor costs and employment: - ULC-based REER declined by about 15 percent since 2008. - More than one third of nearly 4 million jobs lost were recovered by 2017:Q1. - Unemployment rate: 17.2 percent in 2017:Q2. ### Macroeconomic projections and key statistics (selected from Main Economic Indicators, 2012–2022) - Real GDP (percent change): 2012 -2.9; 2013 -1.7; 2014 1.4; 2015 3.2; 2016 3.2; 2017 3.1; 2018 2.5; 2019 2.0; 2020 1.9; 2021 1.7; 2022 1.7. - Private consumption (percent change): 2012 -3.5; 2013 -3.1; 2014 1.6; 2015 2.9; 2016 3.2; 2017 2.7; 2018 2.4; 2019 2.0; 2020 1.8; 2021 1.7; 2022 1.7. - Gross fixed investment (percent change): 2012 -8.6; 2013 -3.4; 2014 3.8; 2015 6.0; 2016 3.1; 2017 4.3. - Private sector debt (percent of GDP): 2012 252.9; 2013 241.4; 2014 230.4; 2015 218.0; 2016 208.7; 2017 200.4; 2018 195.2; 2019 190.4; 2020 185.9; 2021 181.8; 2022 177.7. - Corporate debt: 2012 167.8; 2017 135.5; 2022 118.7. - Household debt: 2012 85.2; 2017 64.9; 2022 59.1. - Credit to private sector (percent change): 2012 -9.9; 2013 -10.2; 2014 -6.5; 2015 -4.2; 2016 -4.1; 2017 0.9; 2018 1.4; 2019 1.4; 2020 1.5; 2021 1.6; 2022 1.7. - Unemployment rate (percent): 2012 24.8; 2013 26.1; 2014 24.4; 2015 22.1; 2016 19.6; 2017 17.3; 2018 15.6; 2019 15.0; 2020 14.3; 2021 13.9; 2022 13.9. - General government balance (percent of GDP): 2012 -10.5; 2013 -7.0; 2014 -6.0; 2015 -5.1; 2016 -4.5; 2017 -3.2; 2018 -2.5. - General government debt (percent of GDP): 2012 85.7; 2013 95.5; 2014 100.4; 2015 99.8; 2016 99.4; 2017 98.5; 2018 97.1; 2019 95.6; 2020 94.3; 2021 93.2; 2022 92.2. - Current account balance (percent of GDP): 2012 -0.2; 2013 1.5; 2014 1.1; 2015 1.4; 2016 1.9; 2017 1.9. - Net international investment position: 2012 -89.9; 2016 -85.7; 2017 -79.9; 2018 -74.4; 2019 -69.3; 2020 -64.6; 2021 -60.1; 2022 -55.7. - Household saving rate (percent of gross disposable income): 2012 8.5; 2013 9.6; 2014 9.0; 2015 8.2; 2016 7.7; 2017 7.4. ### Banking system health and notable events - Asset quality and provisioning: - NPLs for business fell to 8.9 percent of total loans at end-March 2017, 1.2 percentage points lower than a year ago. - NPLs stood at 5.6 percent on a consolidated basis at end-2016. - NPLs remain especially high for lending to SMEs and to the construction and real estate sectors. - Profitability and capital: - Profitability higher than euro area average but declined slightly in 2016:Q4 due to provisioning costs. - Banks used retained earnings to maintain capital buffers during Basel III transitional arrangements. - Spanish banks have lower fully-loaded CET1 ratios than European peers. - Banco Popular resolution (Box 3 highlights): - Banco Popular resolved in June via sale of business to Banco Santander. - All existing shares (Common Equity Tier 1) and the Additional Tier 1 instruments (€1.2 billion) were written down. - Tier 2 instruments (€700 million) converted into new shares and transferred to Santander for €1. - Banco Santander announced plans to raise €7 billion in fresh capital. - Outcome: swift resolution safeguarded financial stability and did not involve public funds; Banco Santander will have a 25 percent share in the SME market in Spain and Portugal. ### Fiscal stance, deficits, and recent measures - Fiscal dynamics: - Narrowing of headline budget deficit masks relaxation of fiscal stance in 2015 and 2016; partial reversal set in 2017. - Primary structural balance moved from a surplus of 1.5 percent of GDP in 2014 to a deficit of 0.3 percent in 2016. - 2016 headline deficit: 4.5 percent of GDP. - Public sector debt: 99.4 percent of GDP in 2016. - 2017 budget and measures: - 2017 budget aims to reduce deficit to EDP target of 3.1 percent of GDP, including revenue measures of about ½ percent of GDP. - Authorities budget another 0.1 percent of GDP for ongoing fiscal support to the financial system (bringing cumulative support to 5 percent of GDP). - Staff projection: - Staff projects a headline deficit of 3.2 percent of GDP for 2017, including 0.1 percent of GDP in support to the financial sector. ### Fiscal outlook and projections (selected and staff remarks) - 2018 staff projection: headline deficit to "comfortably drop below the 3 percent of GDP threshold needed to exiting the EDP." - 2018 measures: approved expenditure ceiling for 2018, if implemented at all government levels, will contribute to lowering the deficit. - Tax change: announced reduction in personal income taxes in 2018 for those in lower income brackets and families facing hardships equals "0.2 percent of GDP". - 2018 projection: staff projects the deficit to reach "2.5 percent of GDP", higher than the deficit target of "2.2 percent", unless offsetting efforts are made. - Medium-term target: authorities plan to lower the headline deficit to "0.5 percent of GDP by 2020", relying on continued expenditure restraint and "0.2 percent of GDP unspecified fiscal effort". - Structural deficit risk: absent concrete measures, IMF staff projects the structural deficit to remain at "around 2½ percent" over the medium term. - Staff recommendation: maintain current pace of structural adjustment by identifying measures that would reduce the structural primary deficit annually by "about 0.5 percent of GDP" until structural balance is reached. - Debt impact: this effort would translate into an additional "4–5 percentage points" reduction of the public debt-to-GDP ratio to "88 percent of GDP by 2022", assuming a fiscal revenue multiplier of "0.6". - Fiscal balance projections (selected table highlights): - Net lending (+) or net borrowing (-) (IMF): -4.5 (2016), -3.2 (2017), -2.5 (2018), -2.1 (2019), -2.0 (2020). - Structural balance (IMF): -3.1 (2016), -2.6 (2017), -2.5 (2018), -2.5 (2019), -2.5 (2020). - Primary structural balance (IMF): -0.3 (2016), 0.2 (2017), 0.2 (2018), 0.2 (2019), 0.2 (2020). - Output gap (IMF): -2.3 (2016), -0.7 (2017), 0.3 (2018), 0.8 (2019), 1.0 (2020). - Memorandum: IMF includes "0.18 percent of GDP" and the authorities include "0.3 percent of GDP" of contingent liabilities related to the financial sector and the motorways in 2017. ### Revenue-side opportunities and structural revenue measures - Improve VAT collections: - Spain had the largest VAT gap in the EU in 2014. - Only "60 percent" of the consumption basket is assessed at the standard VAT rate. - Gradually moving more items to the standard rate with a view to reducing Spain’s VAT gap to the EU average gap of "44 percent" could raise VAT collections by "over 2 percent of GDP". - Reduce tax system inefficiencies: - Broadening the tax base by removing deductions, exemptions, and fiscal incentives could yield "¼–½ percent of GDP" in new revenue. - Raise environmental taxes and levies: - Harmonizing environmental taxes, particularly excises on unleaded petrol, could generate "¼–½ percent of GDP" in additional revenue. - Enhance expenditure efficiency through reviews including pharmaceutical spending and hiring subsidies. ### Social security, pensions, and regional financing - Social security: - Authorities anticipate reducing the social security budget deficit by more than "one percentage point of GDP" to "0.5 percent of GDP by 2020"; staff views this as optimistic. - Authorities project social contributions to increase "about 7 percent in 2017". - Pension reform: - 2011/13 reforms, if implemented as legislated, will ensure pension outlays relative to GDP stay broadly stable over the long run. - Benefit indexation may need to remain at the legal floor of "0.25 percent per annum" for several decades under current projections. - Recommended refinements: implement balancing mechanism (IPR), sustainability factor, gradual rise of statutory retirement age to "67", lengthening the accrual period, increasing contributory years used, avoid one-off adjustments, increase transparency, and encourage supplementary savings (e.g., automatic enrollment with opt-out). - Regional financing and governance: - Reform of regional financing framework required; short-term priorities include enforcement of fiscal framework, strengthen oversight, reinforce conditionality, and monitor regional liquidity mechanisms. - Medium-term: enhance regions’ revenue-raising capacity to match expenditure decentralization. ### Labor market: key findings and ALMPs - Labor market weaknesses and statistics: - "4.3 million Spaniards" seek jobs. - Youth unemployment remains "more than double the national average". - Long-term unemployed account for "almost half of the unemployed". - More than "60 percent" of part-time employment is involuntary. - Number of workers signing more than "10 contracts a year" rose from "150,000 in 2012" to "270,000 in 2016". - ALMPs (Annex I highlights): - Spending on ALMP measures was 0.5 percent of GDP in 2014 versus passive measures at 2.5 percent of GDP. - Between 2012 and 2014, Spain allocated similar shares of ALMP spending to training, start-up incentives, direct job creation, and employment incentives. - Coverage fell from 84 to 25 percent (people wanting to work participating in ALMPs) between 2008 and 2014. - Only 2 percent of vacancies are handled by Public Employment Services (EU average 10 percent). - One employee of Public Employment Services oversees more than 250 jobseekers (OECD, 2017). - In 2015:Q1, only 0.5 percent of low-skilled unemployed for 1–2 years benefited from training programs offered by the Public Employment Services. - Recommended ALMP improvements: - Strengthen Public Employment Services capacity, increase staff-to-jobseeker ratios, implement profiling and digitization, establish single point of contact. - Better target youth and long-term unemployed with skills training aligned to employer needs. - Increase effective public-private collaboration and base ALMPs on rigorous evaluation for cost-effectiveness. ### Structural reforms, productivity, and firm growth impediments - Productivity challenges: - Productivity in manufacturing, trade and market services considerably lower than EU peers; corporate structure dominated by low-productivity small and micro firms. - Firm-size TFP gaps in manufacturing among the largest in Europe. - Remaining impediments: - Slow implementation of Market Unity Law; Constitutional Court decision affects one principle but provided ways to address it. - Remaining regulatory entry barriers, administrative burdens, delayed liberalization of professional services. - Size-related regulations persist (reporting, auditing, labor regulation). - Equity and credit financing for young and innovative startups limited; need to deepen market-based financing. - Low private R&D investment; need to increase efficiency of public R&D and public-private cooperation. - Authorities’ stance: - Commitment to maintain and deepen reforms; developing a strategy to amend size-contingent regulations (over 100 identified). ### Financial sector institutional reforms and macroprudential policy - FSAP priorities: - Address remaining weaknesses and legacy issues; prepare to handle headwinds; strengthen and modernize institutional arrangements. - Supervisory and resolution enhancements: - Apply supervisory actions to incentivize NPL reduction; enhance insolvency framework and out-of-court restructuring. - Conclude merger of two state-owned banks and divest public ownership by end-2019. - Review Sareb business plan and consider accelerating asset sales. - Prudential oversight and governance: - Improve corporate governance and resolvability in credit cooperative sector. - Review fragmentation of resolution responsibilities. - Improve insurance sector asset-liability matching and AML/CFT resourcing for SEPLAC. - Establish a legislatively-based Systemic Risk Council chaired by the Bank of Spain and strengthen Bank of Spain’s systemic surveillance role. - Legal basis for stronger macroprudential tools, possibly including limits on loan-to-value and debt service-to-income. ### Productivity, investment recovery, and employment dynamics (Box summaries) - Investment recovery: - Broad-based across sectors; credit flowing to financially healthier firms; corporate savings used to finance investment and repay debt. - In 2015, about 40 percent of all firms raised investment (much lower among SMEs). - Probability to obtain a loan about 10 percentage points higher for financially stronger firms. - Employment: - Recovered more than a third of almost 4 million jobs lost. - Services account for majority of employment creation; 79 percent in services in 2016 (vs. 69 percent in 2007). - Temporary contracts accounted for a bit more than half of new jobs. - Regional variation: unemployment ranges from ~13 percent in the Northeast to almost 28 percent in the South. ### External Sector Assessment and stress tests (Appendix II) - External position: - EBA CA regression suggests a CA surplus of 1.8 percent of GDP. - Given external stability considerations, a CA norm in the range of 2–4 percent of GDP necessary to strengthen the NIIP by about 5 percent of GDP annually over next 5–10 years. - External and domestic risk assessment (RAM highlights): - Structural weak growth in key advanced economies: Relative Likelihood High; Impact if Realized Medium. - Retreat from cross-border integration: Relative Likelihood Medium; Impact Medium. - European bank distress: Relative Likelihood Medium; Impact Medium. - Policy uncertainty: Relative Likelihood High; Impact Medium. - Domestic risk of weak implementation of fiscal commitments and reforms: Relative Likelihood Medium; Impact High. - Debt Sustainability Analysis (selected baseline and stress-test outcomes): - Baseline public debt path: projected decline slowly from peak 100.4 percent of GDP in 2014 to 92.2 percent of GDP in 2022. - Gross financing needs: 19 percent of GDP in 2017 (highest in euro area); projected 15.8 percent of GDP in 2022. - Policy priority: an annual structural adjustment of about ½ percent of GDP over the medium term would bring debt to around 88 percent of GDP by 2022—4–5 percentage points lower than baseline. - Stress-test scenarios (selected outcomes): - Growth shock (2018–19): debt-to-GDP reaches 106 percent in 2019, declines to 101.8 percent in 2022. - Primary balance shock (2018–19): debt-to-GDP peaks at 99.2 percent in 2019, declines to 93.8 percent in 2022. - Interest rate shock (2018–22): effective interest rate increases to 4.0 percent by 2022; debt-to-GDP 94.6 percent in 2022. - Combined shock: debt-to-GDP increases to 107.1 percent in 2019, remains near this level through 2022. - Contingent liability shock (one-time increase in non-interest public expenditures equivalent to 10 percent of banking sector assets): primary deficit rises to 10 percent of GDP in 2018; gross financing needs reach 27.7 percent of GDP; debt-to-GDP peaks at 113 percent in 2019. - External DSA scenarios: - Baseline external debt projected to decline to about 144 percent of GDP in 2022. - Historical shock scenario could raise external debt to 197 percent of GDP by 2022. ### Inflation, employment, national accounts, and authorities’ views (statement excerpt) - Inflation and prices: - Headline inflation was 0.1 percentage point higher than in July and June. - Core inflation decelerated to 1.2 percent—0.2 percentage point lower than the July reading. - Employment: - Employment grew by 2.8 percent y-o-y in 2017:Q2; number of unemployed down to 3.9 million (lowest since 2009:Q1). - Employment creation around 3 percent; IMF projects unemployment around 15 percent in 2018. - National accounts revisions: - Real GDP growth revised to 3.4 percent in 2015 and 3.3 percent in 2016. - In 2016, level of GDP at current prices 0.4 percent higher than previous estimate. - Authorities’ views: - Authorities concur with staff on need for fiscal consolidation and pension sustainability but disagree with some revenue-side recommendations (e.g., increasing VAT base), citing competitiveness and equity concerns. - Authorities support many FSAP/FSAs recommendations and institutional reforms; see merit in establishing a Systemic Risk Council. *Italic: Source: IMF staff report excerpts for the 2017 Article IV Consultation for Spain (staff report dated August 8, 2017) and related annexes and boxes as provided in cr17319.* ### 8.4 percent of total loans at end-June 2017. Nevertheless, NPLs remain especially elevated for ### cr17319 - 8.4 percent of total loans at end-June 2017. Nevertheless, NPLs remain especially elevated for ### Executive Board Assessment - Directors welcomed Spain’s continued strong and balanced growth and healthy job creation, noting the contribution of past structural reforms to competitiveness, flexibility, and resilience. - Directors observed persistent structural weaknesses and vulnerabilities, including high unemployment and lagging productivity relative to EU peers, and vulnerable public and private balance sheets. - Recommended policy directions: - Gradual fiscal tightening. - Preserve and deepen structural reforms to reduce structural unemployment, strengthen the business environment and competition, and make the financial sector more resilient in line with recommendations in the Financial Sector Stability Assessment (FSSA). - Fiscal policy guidance: - Maintain the current pace of adjustment until structural balance is reached. - Emphasize revenue-side measures: gradually reduce the number of goods and services that qualify for reduced VAT rates, reduce tax system inefficiencies, and raise environmental taxes, while adequately shielding vulnerable groups. - Apply the expenditure rule and increase expenditure efficiency. - Fully implement ongoing pension reforms and publicly disclose reform tradeoffs to support retirement planning. - Labor market guidance: - Adopt a holistic approach including improvements in the quality of education and training. - Use well-designed and targeted active labor market policies and enhanced Public Employment Services to help low-skilled youth and the long-term unemployed return to work. - Further reduce labor market segmentation. - Structural and competition reforms: - Accelerate competition-enhancing reforms: fully implement the Market Unity Law, liberalize professional services, ease access to equity financing for startups, and make public R&D spending more efficient. - Financial sector guidance: - Accelerate bank balance sheet cleanup, including ambitious NPL reduction. - Raise high-quality capital and reduce operating costs to improve profitability and resilience. - Rigorously monitor interest rate and bond market risks; focus on contagion risk within the financial system and cross-border spillovers. - Expand the macroprudential toolkit; establish a systemic risk council to augment risk oversight, policy coordination, and crisis prevention. ### Key Issues / Context - Recovery status: - Spain is in the fourth year of economic expansion; GDP, consumption, and non-construction investment have rebounded close to pre-crisis levels. - Structural shift from construction to services: construction contribution about 6 percent of gross value added (post-crisis). - Drivers of recovery: - Wage moderation and labor market reforms improved competitiveness and job creation. - Banking sector reforms enhanced resilience and allocation of credit to more productive firms. - Spain benefited from low oil prices, ECB monetary easing, and fiscal relaxation in 2015–16. - Remaining challenges: - High structural unemployment relative to Europe. - Much post-crisis growth in lower-skill, lower-productivity sectors. - Public and private sector balance sheets remain vulnerable; public sector debt around 100 percent of GDP. - High level of non-performing loans (NPLs) in parts of the financial sector. ### Policy Priorities (Staff report highlights) - Fiscal: - Rebuild buffers and create fiscal space to cushion future shocks; rely more on indirect taxes. - Full implementation of ongoing pension reforms and greater disclosure of reform tradeoffs. - Labor market: - Targeted, coordinated, and focused active labor market policies to reduce long-term disenfranchisement of low-skilled and long-term unemployed workers. - Further steps to reduce labor market duality. - Structural reforms: - Shift toward higher value added sectors; reduce within-sector inefficiencies. - Implement Market Unity Law fully, remove size-related requirements, ease access to equity financing for startups, and improve public R&D efficiency. - Financial sector: - Complete crisis legacy clean-up: address non-performing loans, capital, privatization of state-owned banks, medium-term bank funding, operations of the asset management company, the credit cooperative sector, and the supervision and resolution frameworks. ### Macroeconomic Projections and Key Statistics (selected from Main Economic Indicators, 2012–2022) - Real GDP (percent change): 2012 -2.9; 2013 -1.7; 2014 1.4; 2015 3.2; 2016 3.2; 2017 3.1; 2018 2.5; 2019 2.0; 2020 1.9; 2021 1.7; 2022 1.7. - Private consumption (percent change): 2012 -3.5; 2013 -3.1; 2014 1.6; 2015 2.9; 2016 3.2; 2017 2.7; 2018 2.4; 2019 2.0; 2020 1.8; 2021 1.7; 2022 1.7. - Gross fixed investment (percent change): 2012 -8.6; 2013 -3.4; 2014 3.8; 2015 6.0; 2016 3.1; 2017 4.3. - Private sector debt (percent of GDP): 2012 252.9; 2013 241.4; 2014 230.4; 2015 218.0; 2016 208.7; 2017 200.4; 2018 195.2; 2019 190.4; 2020 185.9; 2021 181.8; 2022 177.7. - Corporate debt: 2012 167.8; 2017 135.5; 2022 118.7. - Household debt: 2012 85.2; 2017 64.9; 2022 59.1. - Credit to private sector (percent change): 2012 -9.9; 2013 -10.2; 2014 -6.5; 2015 -4.2; 2016 -4.1; 2017 0.9; 2018 1.4; 2019 1.4; 2020 1.5; 2021 1.6; 2022 1.7. - Unemployment rate (percent): 2012 24.8; 2013 26.1; 2014 24.4; 2015 22.1; 2016 19.6; 2017 17.3; 2018 15.6; 2019 15.0; 2020 14.3; 2021 13.9; 2022 13.9. - GDP deflator (percent): 2012 0.1; 2013 0.4; 2014 -0.3; 2015 0.5; 2016 0.3; 2017 1.2; 2018 1.5. - HICP (average): 2012 2.4; 2013 1.5; 2014 -0.2; 2015 -0.6; 2016 -0.3; 2017 2.0. - General government balance (percent of GDP): 2012 -10.5; 2013 -7.0; 2014 -6.0; 2015 -5.1; 2016 -4.5; 2017 -3.2; 2018 -2.5. - General government debt (percent of GDP): 2012 85.7; 2013 95.5; 2014 100.4; 2015 99.8; 2016 99.4; 2017 98.5; 2018 97.1; 2019 95.6; 2020 94.3; 2021 93.2; 2022 92.2. - Current account balance (percent of GDP): 2012 -0.2; 2013 1.5; 2014 1.1; 2015 1.4; 2016 1.9; 2017 1.9. - Net international investment position: 2012 -89.9; 2016 -85.7; 2017 -79.9; 2018 -74.4; 2019 -69.3; 2020 -64.6; 2021 -60.1; 2022 -55.7. - Household saving rate (percent of gross disposable income): 2012 8.5; 2013 9.6; 2014 9.0; 2015 8.2; 2016 7.7; 2017 7.4. ### Financial Sector Findings - NPLs: 8.4 percent of total loans at end-June 2017; NPLs remain especially elevated for some sectors. - Private sector deleveraging reduced the debt-to-GDP ratio by 70 percentage points from its pre-crisis peak to end-2016. - Banking system profitability is higher than the euro area average but declined and remains challenged by low interest rates, high legacy problem assets, and continued excess capacity. - Systemic interconnections are rising with cross-sectoral and cross-border claims picking up. - FSSA findings: significant progress in strengthening banking sector soundness, but remaining weaknesses and legacy issues persist. - Recommended financial sector actions: - Accelerate bank balance sheet cleanup and ambitious NPL reduction. - Increase high-quality capital and reduce operating costs. - Monitor interest rate and bond market risks and contagion risk across the financial system. - Expand macroprudential toolkit and consider establishing a systemic risk council. - Address privatization of state-owned banks, medium-term bank funding, operations of the asset management company, the credit cooperative sector, and supervision and resolution frameworks. *Source: IMF staff report excerpts for the 2017 Article IV Consultation for Spain (staff report dated August 8, 2017).* ### 5. Spain’s balanced recovery has continued, outpacing most EU peers. Growth reached ### 5. Spain’s balanced recovery has continued, outpacing most EU peers. Growth reached ### Growth, demand composition, and inflation - Growth reached 3.2 percent in 2016 and remained robust in the first half of 2017 (3.1 percent y-o-y). - Consumption, investment, and net exports all made positive contributions. - Core inflation remained subdued at 0.8 percent in 2016 and 1.2 percent (y-o-y) in June. - Headline inflation jumped to 3 percent (y-o-y) in January and February before declining to 1.5 percent (y-o-y) in July, reflecting base effects from an increase in global energy prices and the one-off effects of electricity tariff adjustments. ### External sector and current account - Spain recorded its fourth consecutive annual current account surplus. - In 2016, the external current account increased by 0.6 percentage points, to 1.9 percent of GDP. - Improvement drivers: smaller energy trade deficit in the context of low oil prices; sustained strong performance of services’ exports (including tourism); and lower interest payments. - The trade surplus of non-oil goods declined amid a slight deceleration of export volumes and lower-than-expected imports. - Real effective exchange rate (REER) barely appreciated in 2016 with continued wage and price moderation. - Number of regular exporters increased by 4 percentage points (regular exporters defined as those that have exported for at least four consecutive years). ### Labor costs, competitiveness, and employment - Unit labor costs (ULC) remained broadly unchanged during the recovery; individual wages grew at modest rates. - ULC-based REER declined by about 15 percent since 2008. - Spain’s ULC declined by around 6 percent between 2010–16, mainly because of the drop in employment until 2013 and, more recently, due to the increase in output. - Cumulative growth of wages during 2010–16 was below 1 percent, compared with a 34 percent increase during 2001–09. - More than one third of the nearly 4 million jobs lost during the crisis were recovered by 2017:Q1. - Unemployment rate stood at 17.2 percent in 2017:Q2, a level last seen in 2009:Q1 and 10 percentage points lower than the peak rate in 2013. - Youth and long-term unemployment rates improved but remain among the highest in Europe. - In 2016, temporary new hires still outnumbered permanent ones. ### Net international investment position (NIIP) and external vulnerabilities - NIIP improved from -98 percent of GDP in 2014 to -86 percent in 2016, driven by current account surpluses and GDP recovery. - Private sector continued to deleverage and generated net savings after the crisis. - NIIP of the general government and the central bank increased, reflecting mostly higher liabilities under Target2 as the ECB expanded its asset purchase program. - Total gross debt of the general government and the central bank held by non-residents stood at 85 percent of GDP at end-2016, with mitigating risk factors including a favorable maturity structure. - Staff assessment: the external position in 2016 was weaker than consistent with medium-term fundamentals and desirable policy settings. - Staff considers the cyclically-adjusted current account is about 1 to 3 percent of GDP weaker than implied by fundamentals and desirable policies. - Staff considers the REER is about 5–10 percent overvalued. ### Financing, bank lending, and deleveraging - Financing conditions remained favorable, but bank lending continued to contract. - Bank credit growth stayed negative though contraction slowed, reflecting weak credit demand as corporates and households deleveraged. - Total private sector debt-to-GDP ratio fell by 8 percentage points in 2016. - Certain segments remain overly leveraged: corporates in construction and real estate services; households that are low-income, jobless, and self-employed. - Improved firm profit margins have enabled financing of new investment with retained earnings; large corporations shifted to more non-bank financing. - Demand for home purchases only recently started to pick up from a very low base. - Ongoing deleveraging does not appear to impede strong consumption and investment as corporates’ and households’ financing needs remain limited. ### Banking system health and episodes of stress - Asset quality improved: nonperforming loans (NPLs) for business in Spain fell to 8.9 percent of total loans at end-March 2017, 1.2 percentage points lower than a year ago. - NPLs stood at 5.6 percent on a consolidated basis at end-2016. - NPLs remain especially high for lending to SMEs and to the construction and real estate sectors; foreclosed assets have not declined given the roughly equal pace of foreclosures and sales. - Profitability, though higher than in the euro area, declined slightly in 2016:Q4, largely due to high provisioning costs of a large bank. - Capitalization broadly stable as banks used retained earnings to maintain capital buffers during the transitional arrangement of Basel III implementation. - Spanish banks generally have ample liquidity due to the ECB’s extraordinary support but have lower fully-loaded common equity tier-1 (CET1) capital ratios than European peers. - Banco Popular encountered substantial deposit outflows and liquidity shortages, was resolved in early June through a purchase by Spain’s largest bank; the step helped strengthen the banking system and safeguard financial stability. - No contagion on banking system deposits, sovereign yields, or bank capital instruments, except for the share price drop of one medium-size bank, partially reversed following a short-selling ban. - Domestic operating conditions remain challenging amid low interest rates, weak credit demand, and still elevated legacy assets. - Internationally, Spanish banks’ overseas subsidiaries continued relatively strong performance despite growing uncertainties in some host countries. ### Fiscal stance, deficits, and recent measures - Narrowing of headline budget deficit masks a relaxation of the fiscal stance in 2015 and 2016, set to partially reverse in 2017. - Reduction in interest bill and the cyclical upturn since 2014 reduced the overall deficit by 2.5 percentage points of GDP since 2013. - Primary structural balance went from a surplus of 1.5 percent of GDP in 2014 to a deficit of 0.3 percent in 2016. - 2016 headline deficit reached 4.5 percent of GDP, marginally lower than the revised EDP target of 4.6 percent of GDP, but 0.9 percentage point wider than initially budgeted. - Revenues underperformed partly due to lower-than-expected VAT and social security revenue. - Higher-than-projected social transfers and unanticipated support for the financial sector pushed expenditure 0.6 percentage points above budget. - Higher deficit of the social security system and central government partly compensated by surpluses at the municipal level. - Regional governments’ compliance with their ambitious deficit target improved significantly compared to 2015 following the central government’s first-time application of corrective measures. - Public sector debt fell marginally to 99.4 percent of GDP. - 2017 budget, adopted in June, aims to reduce the deficit to the EDP target of 3.1 percent of GDP, including through revenue measures of about ½ percent of GDP. - Authorities’ view: solid growth and strong job creation; reform-induced competitiveness gains, private debt reduction, and financial sector cleanup enabling a structural shift to more balanced growth. ### Outlook and risks - Growth projections: around 3.1 percent in 2017 and 2.5 percent in 2018, with the output gap closing in 2018. - Private consumption and investment expected to soften gradually as external tailwinds and fiscal support dissipate. - Consumption growth dampened by continued household deleveraging to strengthen depressed overall net wealth. - Investment growth expected to remain healthy over the medium term, though slower than in 2016, as financial conditions tighten. - Net exports expected to remain a positive contributor; current account surplus projected to stabilize around 2 percent of GDP over the medium term, allowing gradual reduction of the NIIP. - IMF staff estimates potential growth at around 1¾ percent over the medium term, constrained by weak productivity growth, unfavorable labor force demographics, and high structural unemployment. - Slight upward revision in medium-term potential growth versus prior year mainly driven by higher capital accumulation and somewhat improved productivity due to better resource allocation and improved labor market efficiency. - Inflation projected: picking up strongly in the year to 2.0 percent due to base effects from higher fuel prices and electricity tariff adjustments, moderating to 1.4 percent in 2018 in the absence of second-round effects. - Risks: - Near term upside risks; medium-term risks tilted to the downside. - External risks: rising protectionism, Brexit negotiation uncertainties, US policy uncertainties, weaker emerging market conditions affecting global banks’ profitability. - Monetary normalization risks: investors questioning high-debt countries’ ability to cope with higher borrowing costs, possible renewed sovereign and financial sector stress. - Domestic risks: reversal of reform achievements, delays in fiscal consolidation limiting shock response capacity, regional independence movements adding uncertainty. - Upside scenarios: momentum from past reforms larger than estimated; stronger-than-anticipated global recovery; pro-EU election outcomes contributing to a more resilient euro area. ### Policy agenda and priorities - Full implementation of past reforms is critical. - Priority measures: gradual fiscal tightening to rebuild buffers; a more deliberate and focused effort to reduce structural unemployment; steps to improve the business environment; further actions to make the financial sector more resilient. - Fiscal constraints and vulnerabilities: - Public debt almost 100 percent of GDP and annual gross financing need relative to GDP the highest in the European Union. - Limited room for counter-cyclical fiscal responses to shocks. - Demographic pressures on age-related spending over medium to long term. - Ongoing fiscal support to the financial system: another 0.1 percent of GDP budgeted in 2017 (bringing cumulative support to 5 percent of GDP). - FSAP-identified risks of contingent liabilities (including from Sareb) and remaining sovereign-bank nexus. - Structural measures underpinning fiscal consolidation in 2017: - Corporate tax measures projected to yield about 0.4 percent of GDP in additional revenue in 2017. - Measures to improve VAT administration and compliance yielded around €600 million more in value added taxes in the first five months of 2017 compared to 2016 (authorities' estimate). - Nominal expenditure growth anticipated to be kept in check at 2.3 percent, largely due to a fall in social benefit outlays as the economy and employment continue to grow. - Budget provides for around 0.1 percent of GDP in spending to cover guarantees issued for public-private partnerships. - Under these policies, staff projects a headline deficit of 3.2 percent of GDP, including 0.1 percent of GDP in support to the financial sector, very close to the EDP target. *International Monetary Fund. Country Report excerpt.* ### 19. However, the planned medium- ### cr17319 - 19. However, the planned medium- ### Fiscal outlook and projections - 2018: staff projects the headline deficit to "comfortably drop below the 3 percent of GDP threshold needed to exiting the EDP." - 2018 measures: approved expenditure ceiling for 2018, if implemented at all government levels, will contribute to lowering the deficit. - Tax change: announced reduction in personal income taxes in 2018 for those in lower income brackets and families facing hardships equals "0.2 percent of GDP". - 2018 projection: staff projects the deficit to reach "2.5 percent of GDP", higher than the deficit target of "2.2 percent", unless offsetting efforts are made. - Medium-term target: authorities plan to lower the headline deficit to "0.5 percent of GDP by 2020", relying on continued expenditure restraint and "0.2 percent of GDP unspecified fiscal effort". - Structural deficit risk: absent concrete measures, IMF staff projects the structural deficit to remain at "around 2½ percent" over the medium term, above the medium-term objective of structural balance by 2020 under European and national rules. - Staff recommendation: maintain the current pace of structural adjustment by identifying measures that would reduce the structural primary deficit annually by "about 0.5 percent of GDP" until structural balance is reached. - Debt impact: this effort would translate into an additional "4–5 percentage points" reduction of the public debt-to-GDP ratio to "88 percent of GDP by 2022", assuming a fiscal revenue multiplier of "0.6". ### Fiscal balance projections and recent fiscal dynamics - Expenditures: expenditures are already projected to fall by "2.6 percentage points of GDP during 2017–20". - Table highlights (selected figures as presented): - Net lending (+) or net borrowing (-): IMF -4.5 (2016), -3.2 (2017), -2.5 (2018), -2.1 (2019), -2.0 (2020). - Authorities: -4.5 (2016), -3.1 (2017), -2.2 (2018), -1.3 (2019), -0.5 (2020). - Structural balance (IMF): -3.1 (2016), -2.6 (2017), -2.5 (2018), -2.5 (2019), -2.5 (2020). - Primary structural balance (IMF): -0.3 (2016), 0.2 (2017), 0.2 (2018), 0.2 (2019), 0.2 (2020). - Output gap (IMF): -2.3 (2016), -0.7 (2017), 0.3 (2018), 0.8 (2019), 1.0 (2020). - Memorandum: IMF includes "0.18 percent of GDP" and the authorities include "0.3 percent of GDP" of contingent liabilities related to the financial sector and the motorways in 2017. ### Revenue-side opportunities and recommended structural measures - General point: room for structural measures lies mostly on the revenue side; structural revenue measures could contribute to reducing the deficit and debt and expand fiscal space for priority spending. - Improve VAT collections: - Spain had the largest VAT gap in the EU in 2014. - Only "60 percent" of the consumption basket is assessed at the standard VAT rate. - Gradually moving more items to the standard rate with a view to reducing Spain’s VAT gap to the EU average gap of "44 percent" could raise VAT collections by "over 2 percent of GDP". - Reduce tax system inefficiencies: - Broadening the tax base by removing deductions, exemptions, and fiscal incentives could yield "¼–½ percent of GDP" in new revenue. - Raise environmental taxes and levies: - Harmonizing environmental taxes, particularly excises on unleaded petrol, could generate "¼–½ percent of GDP" in additional revenue. - Enhance expenditure efficiency: - Planned expenditure reviews, including pharmaceutical spending and hiring subsidies, could raise quality and efficiency; reviews should be expanded to areas such as education spending. ### Social security and pension finances - Social security deficit target: authorities anticipate reducing the social security budget deficit by more than "one percentage point of GDP" to "0.5 percent of GDP by 2020". - Staff view: this appears optimistic; authorities project social contributions to increase "about 7 percent in 2017" despite a downward trend in the contributions-to-GDP ratio since 2011. - Local governments: local governments may record an aggregate surplus in 2017 (as in 2016), which could buffer underperforming contributions. - Pension reform implications: - The 2011/13 reforms, if implemented as legislated, will ensure pension outlays relative to GDP stay broadly stable over the long run. - To do so, benefit indexation will need to remain at the legal floor of "0.25 percent per annum" for several decades under current projections. - This implies a significant risk of reduction in purchasing power for current and future pensioners, though Spain’s benefits in 2060 would remain above the EU average. - Recommended refinements to balance sustainability and acceptability: - Implement the significant pension reforms of 2011 and 2013 in full, including the balancing mechanism (indexation of pension revaluation (IPR)), sustainability factor, gradual rise of statutory retirement age to "67", lengthening the accrual period, and increasing contributory years used in pension calculation. - Avoid one-off adjustments (for example, to pension indexation). - Possible parametric refinements: raise contribution floor and ceilings faster than pensions, link statutory retirement age directly to life expectancy, extend contributory period required for full pension, lengthen pensionable earnings reference period to the full contribution period. - Increase transparency about the current and future health of the pension system. - Encourage supplementary savings, e.g., automatic enrollment with opt-out in a government-administered portable savings plan. ### Regional financing framework and public sector governance - Reform need: regional financing framework requires reform; two expert committees were created in early 2017 and presented reports at end of July. - Short-term priorities: enforce existing fiscal framework, strengthen oversight institutions and procedures, reinforce conditionality, and step up monitoring under regional liquidity mechanisms for non-compliant regions. - Enforcement: use of enforcement tools in 2016 improved regional compliance with deficit targets. - Medium-term: enhance regions’ revenue-raising capacity to match expenditure decentralization. ### Labor market: key findings and policy recommendations - Labor market weaknesses: - Unemployment: "4.3 million Spaniards" seek jobs. - Youth unemployment remains "more than double the national average". - Long-term unemployed account for "almost half of the unemployed". - More than "60 percent" of part-time employment is involuntary. - Active Labor Market Policies (ALMPs): - Individualized support is insufficient and imperfectly targeted. - Participation: less than "0.3 percent" of the low-skilled long-term unemployed benefited from training programs offered by the Public Employment Services in "2015:Q1". - Funding: ALMPs are funded by a relatively low level of spending on ALMPs per person wanting work; authorities increased spending on ALMP measures and labor market services significantly in "2015–16" and budgeted another increase for "2017". - Recommendations to improve ALMPs: - Concentrate expenditure on one or two specific ALMP measures as many EU countries do. - Use OECD peer review to guide resource allocation and program selection. - Implement one-stop shops providing unemployment benefits, profiling, job search training, individualized counselling, tailored job offers, and monitoring of job search efforts (examples: Denmark and Germany). - Better-managed use of the EU’s Youth Guarantee, refined collaboration with private placement agencies, enhanced coordination between active and passive policies. - Strengthen Public Employment Services’ capacity for individualized support, better-target demand-driven skills training, and conduct regular evaluations. - Labor market segmentation: - Spain has one of the highest shares of temporary employment in the EU; many contracts are of very short duration. - Number of workers signing more than "10 contracts a year" rose from "150,000 in 2012" to "270,000 in 2016". - Transition rates from temporary to permanent contracts are very low relative to the EU average, though they have increased after reforms. - Policy suggestions: improve attractiveness of open-ended contracts, reduce administrative and legal obstacles, develop a comprehensive plan to fight labor market segmentation as agreed in 2014. ### Structural reforms and productivity - Productivity challenge: productivity levels in manufacturing, trade and market services are considerably lower than in EU peers, partly due to corporate structure dominated by low-productivity small and micro firms. - Positive signs: exit of low-productivity firms has lifted total factor productivity (TFP) growth after the crisis; resources appear to be flowing to more productive and financially healthier firms following earlier banking sector reforms. - Firm-size gap: TFP gaps between small and large firms in manufacturing are among the largest in Europe. - Suggested focus: raise productivity via reforms that support firm growth, resource reallocation to higher productivity firms, and measures addressing corporate structure and market functioning. *Source: IMF staff report excerpt (cr17319).* ### 33. Progress with addressing the remaining impediments that hold back firm growth and ### 33. Progress with addressing the remaining impediments that hold back firm growth and ### Remaining impediments to firm growth and productivity - Implementation of the Market Unity Law, which establishes a single market in Spain by eliminating differential treatment of economic activity by the central, regional, and local authorities, has been slow. The recent decision by the Constitutional Court found one principle of the Market Unity Law to be in violation with the constitution, which could delay its implementation, but the court also laid out ways to address the principle. - Further steps are needed to eliminate remaining regulatory entry barriers and administrative burden from licensing requirements that are affecting competition and firm TFP growth particularly in sectors more exposed to regulation (SIP 2016, Chapter 2). - Liberalization of professional services remains delayed; jumpstarting it would level the playing field, increase transparency, and lower costs in many currently protected professions. - Replacing the lower corporate income tax rate for small firms with targeted support for startups has addressed one disincentive for firm growth; remaining size-related rules and regulations, including on reporting, auditing, and labor regulation, should be tackled to further stimulate firm growth and productivity. - Access to credit, including for SMEs, has improved, with interest rates for SMEs below those in Germany. But equity and credit financing for young and innovative start-ups is still limited, underscoring the need to deepen market-based financing via alternative exchanges, venture capital, and securitization. The judicious use of guarantees and direct lending by the Instituto de Crédito Oficial (ICO) remains relevant for riskier firms and projects. - Low private research and development (R&D) investment and limited firm ability to innovate remain largely unaddressed. Measures to increase the efficiency of public R&D, improve public-private cooperation, and enhance private R&D investment could facilitate development of higher value-added industries and jobs. ### Authorities’ views on reform pace and priorities - The authorities reaffirmed commitment to maintain and deepen reforms, while noting the time needed to generate consensus given the fragmented parliament. - They identified more than 100 size-contingent regulations among fiscal, accounting, auditing and labor regulations and are developing a strategy to incentivize business growth that will include amendments of these regulations. - The authorities acknowledged the Constitutional Court decision would slow somewhat the pace of the Market Unity Law implementation but noted it affects only about 20 percent of the cases dealt with in the framework of mechanisms available to operators to claim against administrative rules and decisions contrary to the principles of the Law. - They will attach higher priority to amending regulations that cause frequent complaints from the private sector. - Authorities noted that size-related regulations hamper growth of innovative firms and that reform of the education system is needed to enhance innovation. ### Financial sector: complete crisis legacy clean-up and reform agenda - The Financial Sector Assessment Program (FSAP) highlighted three policy priorities: addressing banks’ remaining weaknesses and legacy issues, preparing to handle headwinds, and strengthening and modernizing institutional arrangements to ensure the system remains sound and resilient and supports economic growth. - Lowering impaired assets, especially in banks that have lagged in adjustment, deserves immediate attention. Efforts should build on the ECB’s guidance on reducing NPLs, the application of revised domestic accounting rules on provisions (Bank of Spain Circular 4/2016), and careful analysis of banks’ property value assumptions. - Supervisory actions should be applied to incentivize progress. Enhancing the insolvency framework and fostering use of out-of-court agreements on payments processes for SMEs would support more efficient debt restructuring. - The merger of the two state-owned banks, which started in July, should be concluded without delay, paving the way for divestment of public ownership by the deadline that was extended to end-2019. - Sareb has realized losses since inception; it may need to accelerate asset sales at a higher discount to generate sufficient cashflows, and Sareb’s business plan should be regularly reviewed and adjusted to ensure consistency with the macrofinancial outlook. ### Banking sector weaknesses and policy recommendations - Address profitability pressures: - Banks’ profitability has improved but return on equity is still lower than the cost of capital. - Main drivers include low interest rates in the euro area, Spain-specific continued private sector deleveraging, sizeable provisioning costs, and relatively high operating costs in relation to assets. - To structurally improve profitability, explore further consolidation through mergers, rationalization of business lines and branch networks, and diversification of earnings away from interest income. - Raise more high-quality capital: - Spanish banks lag European peers in fully-loaded CET1 capital and leverage ratios and should further increase capital to compensate for phase-out of regulatory exemptions. - More capital would support greater efforts to reduce impaired assets and provide buffers against unexpected shocks, including interest rate and sovereign shocks. - Prepare for the ECB’s exit from accommodative policies: - Banks currently benefit from ample liquidity and cheap funding via TLTROs and the asset purchase program. - FSAP stress tests suggested potential liquidity strains from significant funding outflows and non-negligible trading losses and valuation effects from fixed-income portfolios. - Enhanced monitoring and management of liquidity and interest rate risks are needed; banks may need to adjust liability structures to fulfill new regulatory requirements such as MREL. ### Prudential oversight, macroprudential toolkit, and institutional reforms - Prudential oversight and resolution could be enhanced: - FSAP identified room to improve corporate governance of Spanish financial institutions. - Comprehensive reform of the credit cooperative sector is essential to strengthen corporate governance and improve resolvability, important also for smaller banks. - Review the current setup that separates preventive and executive resolution responsibilities of banks and investment firms to address fragmentation of resolution arrangements over time. - Insurance sector: improve matching of assets and liabilities. - Enhance the AML/CFT regime, including by providing additional resources to the AML/CFT supervisor (SEPLAC). - Strengthen systemic risk surveillance and the macroprudential toolkit: - Significant international presence of Spanish banks increases cross-border spillovers; intra-system connectedness is building via conglomerate linkages, non-traditional banking activities, and the systemic role of the domestic public debt market. - A legislatively established Systemic Risk Council, chaired by the Bank of Spain and comprising other financial oversight authorities and the Treasury, should strengthen systemic risk oversight and inter-agency coordination. - Strengthen the Bank of Spain’s role to lead systemic risk surveillance in support of the proposed Systemic Risk Council. - Establish legal basis for more effective macroprudential tools, including possibly limits on loan-to-value and debt service-to-income given the importance of real estate exposures on banks’ balance sheets. - Governance and institutional changes planned by government: - More transparent selection process for senior appointments at financial sector oversight authorities. - Establishment of an independent insurance and pension supervisory agency. - Transfer responsibility for general purpose accounting standards and audit oversight from an institute within the Ministry of Economy to the capital markets regulator. - Introduce a single ombudsman scheme to centralize and strengthen consumer complaints handling related to financial products. - FSAP stressed adequate resources and appropriate information sharing related to these changes; recommended improving deposit insurance fund’s payout system and setting up a guarantee scheme for insurance policyholders. ### Staff appraisal: macro risks, fiscal buffers, pensions, and employment - Growth outlook and vulnerabilities: - The Spanish economy has become more competitive, flexible and resilient but growth momentum is set to slow without further reform. - Dynamic expansion expected to continue over the next couple of years with upside risks in the near term; without further structural reforms and rebuilding fiscal buffers the economy remains vulnerable to shocks and some segments risk being left behind. - Over the medium term, growth is projected to dip below 2 percent and unemployment to remain in double digits. - Fiscal policy and public debt: - Spain’s high public debt ratio, close to 100 percent of GDP, leaves little room for fiscal policy to respond to negative shocks. - Population dynamics imply significant age-related spending pressure over the medium term. - Relying beyond 2017 on output growth alone to reduce headline deficit and debt ratios should be resisted; such an approach would leave a considerable gap in the structural balance (with a deficit of around 2½ percent of GDP) and risk pro-cyclical adjustments when the cycle turns. - All levels of government need to contribute to rebuilding fiscal buffers via enforcement tools in the short run and enhanced incentives and capacity for regional and other governments to build space over the medium term. - Gradual fiscal consolidation would help improve the external position, which is assessed to be weaker than consistent with fundamentals and desirable policies. - Pensions: - Implementing fully the 2011 and 2013 pension reform package will ensure system financial sustainability. - The implied reduction in purchasing power of pensions does not seem widely understood; full transparency is critical, including about the need to complement public pensions with private savings. - If social acceptance requires a smoother transition, the burden of required adjustments should be spread across and within generations through a package of revenue and expenditure measures; avoid one-off revisions (for example to pension indexation) as they could set precedents that undermine sustainability. - Employment and labor market: - Employment creation and better job quality remain priorities; fostering a dynamic, inclusive labor market requires a holistic approach. - Address labor market duality: large share of temporary contracts helped kick-start the recovery but now weighs on productivity and wage growth. - Improve efficiency and design of active labor market policies and address capacity constraints of Public Employment Services to better support employability of the young and long-term unemployed. - Active labor market policies should complement efforts to improve the quality of formal education and training to address skills mismatches and raise productivity. *International Monetary Fund.* ### 47. Raising productivity growth is critical for enhancing Spain’s medium-term economic ### 47. Raising productivity growth is critical for enhancing Spain’s medium-term economic ### Productivity growth and structural reforms - Raising productivity growth is critical for enhancing Spain’s medium-term economic prospects and for faster reduction of vulnerabilities. - Regional coordination is critical but has proven difficult in the implementation of the Market Unity Law, which aims at breaking down administrative barriers and fostering competition. - Revisit regulations linked to the size of firms to remove obstacles that have held them back from expanding. - Increase research and development spending to foster innovation. ### Financial sector: progress and remaining legacy issues - A stronger financial system has emerged after the crisis, but the crisis legacy clean-up is still to be completed to strengthen resilience to new challenges. - Improvements noted: - Solvency and profitability have improved for most banks. - NPLs have come down. - Credit is more readily available. - Adjustments to new regulatory requirements are progressing smoothly. - Remaining weaknesses: - NPLs remain relatively high in a few banks. - Capital ratios lag those of European peers. - The system holds a relatively large share of long-duration sovereign debt. - Recommended bank actions: - Accelerate balance sheet cleanup. - Carefully analyze banks’ property value assumptions and apply supervisory actions to enhance progress. - Continue improving profitability, building capital buffers, and adjusting funding positions. - Credit cooperative sector: - Stronger corporate governance and improved resolvability are critical. ### Financial sector institutional arrangements and macroprudential policy - Strengthen and modernize institutional arrangements to raise preparedness for new risks. - Establish an interagency Systemic Risk Council to: - Enhance systemic risk surveillance and macroprudential decision making. - Address gradually rising intra-system connectedness of the financial system. - Expand the macroprudential toolkit to strengthen the Bank of Spain’s ability to deal with future build-up of risks. - While current resolution arrangements for systemically important banks are working well, review fragmentation of resolution arrangements over time. - Plans to enhance governance of parts of the institutional architecture are welcome. ### Policy cycle recommendation - It is recommended that Spain remain on the standard 12-month Article IV cycle. ### Investment recovery: where investment is going and how it is financed (Box 1) - The investment recovery has been broad-based across sectors. - Support factors: - Credit flowing to financially healthier and more productive firms. - Corporate savings gains. - Behavior by firm health: - Financially weaker firms have reduced their investment and continued to deleverage. - In 2015, about 40 percent of all firms (comprising more than half of aggregate value added) raised their investment. It was much lower among SMEs. - Corporate savings and financing: - Corporate savings have increased in post-crisis years. - Internal funding replaced parts of bank lending and was used to repay debt. - Larger corporates have relied more on equity and bond issuance, which together with new bank loans, financed the investment recovery. - Credit allocation evidence: - Using firm-level loan application data from the Central Credit Registry (Bank of Spain), the probability to obtain a loan is about 10 percentage points higher for financially stronger than weaker firms (proxied by firm indebtedness, interest burden, and lagged non-performing loans). - This sensitivity has increased significantly since the crisis, suggesting banks discriminate more between firms based on financial situation following banking sector reforms. - The difference in TFP between firms whose credit does not diminish and those for which it declines suggests improved allocation of credit, likely explaining part of the gains in aggregate TFP since the crisis. ### Employment creation during the recovery (Box 2) - Spain has recovered more than a third of the almost 4 million jobs lost during the crisis. - Sectoral patterns: - Services account for the majority of employment creation, reflecting a structural shift to two lower-skill segments. - Compared to 69 percent in 2007, 79 percent of Spaniards held service-sector jobs in 2016. - About one quarter of the new jobs are in economic activities benefitting from tourism (INE/Turespaña statistics). - Employment creation in higher-skill segments has picked up, but from a low basis. - The recovery of manufacturing jobs reflects increased competitiveness and export market performance. - Job quality and contracts: - Most jobs have been created in the lower-skill segment; high-productivity sectors such as information and communications experienced high job growth but account for a small share of employment. - Temporary contracts have accounted for a bit more than half of the new jobs. - Some high employment-growth subsectors (professional and technical service activities, accommodation and food services, information and communications) seem to extend more permanent contracts, especially recently. - Regional differences: - Employment in the Canary Islands and the South increased by around 10 percent; it picked up by around 4 percent in the Northwest and Madrid. - In absolute terms, job creation has been strongest in the East. - Unemployment rates vary markedly, from around 13 percent in the Northeast to almost 28 percent in the South, reflecting limited regional labor mobility. - While wholesale and other trade businesses have been main job creators in larger regions (Madrid and the Canary Islands), much of the employment recovery in Northern Spain is owed to increases in public employment. - Employment gains in information and communications have been concentrated in the capital. - Timing and measurement: - Change in employment between 2014:Q1 and 2017:Q1, based on seasonally unadjusted national accounts data. - Change in employees by contract type measured seasonally unadjusted, 2014Q1-2017Q1, thousands of persons, 15 to 64 years old. - Note: Self-employed excluded, who account for around 13 percent of total employment. *SPAIN — INTERNATIONAL MONETARY FUND* ### Box 3. The Resolution of Banco Popular ### Box 3. The Resolution of Banco Popular ### Summary of the event and objectives - Spain’s sixth largest bank, Banco Popular, was resolved in June via sale of business. - The swift and well-coordinated resolution helped safeguard financial stability and did not involve public funds. ### Bank condition and trigger events (timeline of key developments) - Banco Popular had lagged other banks in its balance sheet adjustment and came under market pressure following a series of bad news that led to the bank’s illiquidity. - Banco Popular met all regulatory capital requirements until recently but had sizeable problem assets and was among the weaker banks in the 2016 EBA stress test. - February: the bank announced a €3.5 billion loss for 2016 largely owing to the increase in provisions to accelerate the cleanup of legacy assets. - April: an internal audit uncovered additional provisioning needs of €600 million, and a plan was announced to sell noncore businesses and raise capital. - May: the bank reported another loss of nearly €150 million for 2017:Q1, and put itself up for sale, with a deadline of June 10. - June 1: market pressures intensified, prompted by media reports that Banco Popular might need to be resolved; deposit outflows accelerated, and the Eurosystem approved substantial emergency liquidity assistance on June 2. - Two working days later (Tuesday): Banco Popular could not provide sufficient eligible collateral to obtain further emergency liquidity assistance. Given its incapacity to meet its payment obligations on the next business day, the ECB determined that Banco Popular was failing or likely to fail on liquidity grounds. ### Resolution mechanics and financial treatment of instruments - June 7: the SRB announced that Banco Popular would be resolved under the Bank Recovery and Resolution Directive via sale of business to Banco Santander. - All existing shares (Common Equity Tier 1), and the Additional Tier 1 instruments (€1.2 billion) of Banco Popular were written down. - Tier 2 instruments (€700 million) were converted into new shares, which were transferred to Santander for the price of €1. - Banco Santander also announced that it would make additional provisions for assets acquired from Banco Popular, supported by its effort to raise €7 billion in fresh capital. ### Market structure and competitive impact - Following the purchase, Banco Santander will consolidate its market position in Spain and Portugal. - Banco Santander will become the leading bank in the Spanish SME market, with a 25 percent share. *International Monetary Fund — Box 3. The Resolution of Banco Popular (extracted from cr17319).* ### Annex I. Active Labor Market Policies in Spain ### Annex I. Active Labor Market Policies in Spain ### Executive summary - Cost-effective active labor market policies (ALMPs) could reduce long-term and low-skilled unemployment in Spain, but current evidence points to inefficiencies and limited effectiveness. - Main deficiencies identified: low spending relative to need, diversification across many programs, limited participation rates, capacity constraints in Public Employment Services, weak targeting of vulnerable groups, and scarce evaluation mechanisms. - The government introduced changes to the ALMP strategy (2014–2016 Strategy for Employment Activation and reforms in December 2016), but further improvements are needed. ### Expenditure and participation in ALMPs - Spending on ALMP measures (training and employment subsidies) was 0.5 percent of GDP in 2014 versus passive measures (unemployment benefits) at 2.5 percent of GDP. - Spain spends a larger fraction of GDP on ALMP measures than many EU countries, but its relative share is weaker when adjusted for price level differences (“purchasing power standards” or PPS) and by the number of persons wanting to work. - After declining around 2012, the annual budget for ALMP measures and labor market services increased on average by 13 percent in 2015 and 2016. - Between 2012 and 2014 Spain allocated relatively similar shares of overall ALMP spending to: - training, - start-up incentives, - direct job creation, - employment incentives (to a lesser extent). - At the regional level: - On average each region applies 63 different measures and services. - The 2016 Annual Employment Policy Plan lists 530 policies, of which only 52 are common to all regions and the rest are region-specific. ### Coverage, targeting, and outcomes - Coverage fell sharply: between 2008 and 2014, the percentage of people wanting to work participating in ALMP measures dropped from 84 to 25 percent. - International comparisons (2014–15): - Spain’s participation rate in ALMPs was greater than Greece and Italy but lower than Portugal. - Labor market services coverage: - Only 2 percent of vacancies are handled by the Public Employment Services (EU average 10 percent). - The share of the unemployed that contacted the Public Employment Services to seek work was 27.5 percent in 2015 (the lowest rate in the EU). - Public Employment Services capacity constraint: - One employee of Public Employment Services oversees more than 250 jobseekers (OECD, 2017). - Insufficient targeting of vulnerable groups: - In 2015:Q1, only 0.5 percent of low-skilled unemployed for 1–2 years benefited from training programs offered by the Public Employment Services; an even smaller fraction for low-skilled unemployed for more than two years (Jansen, 2016). - Long-term unemployed programs: - Three main programs: Renta Activa de Inserción, PREPARA plan, Employment Activation Program (PAE). - PAE includes a personal tutor and reportedly helped one third of its participants find a job, but it has only covered about half of the initially estimated 400,000 persons. - Youth Guarantee: - Spain received the highest share in total EU funding to implement the Youth Guarantee, but the program had a slow start due to narrowly defined eligibility criteria and inadequate monitoring systems. ### Institutional issues and recent measures - Decentralized delivery structure: - Central government manages unemployment benefits; provision of ALMPs is decentralized at regional levels. - Delivery of social and employment services is divided across national and regional Public Employment Services and social services, weakening ties between passive and active policies and reducing efficiency and effectiveness. - 2014–2016 Strategy for Employment Activation introduced: - national strategic objectives (e.g., better targeting long-term unemployed), - increased budget and a common catalogue of ALMPs, - funding to regions partially linked to results, - monitoring through performance indicators, - a common IT system, - enhanced private-public collaboration in labor intermediation and training. - Implementation challenges: - Progress has been slow and uneven across regions. - Performance indicators do not sufficiently focus on program impact. - Many regions still operate their own IT systems. - Several regions have not worked with or have interrupted collaborations with private job-placement agencies. - Revisions in December 2016: - A new action plan to support one million long-term unemployed with a budget of €515 million, envisaging more individualized assistance and development of profiling tools. - All young people registered as unemployed with the Public Employment Services are now eligible for support under the Youth Guarantee. - Extension of the PAE until 2018 and changes aimed at increasing participants. - Government pledged enhanced management and implementation of the Youth Guarantee scheme. ### The way forward — recommended improvements - Strengthen Public Employment Services capacity: - Appropriate training to staff. - Higher staff-to-jobseeker ratios. - Profiling and better use of digitization to improve job search assistance. - Establish a single point of contact for labor market services and assistance. - Better targeting and program design: - Focus ALMP measures for youth and long-term unemployed on skills training aligned with private employers’ needs. - Re-training for low-skilled long-term unemployed in collaboration with vocational education and training institutions. - Public-private collaboration: - Increase involvement of private providers in job placement with a balance of reasonable incentives and service quality. - Orient public-private collaboration mainly to those furthest from the labor market. - Disseminate best practices across regions. - Monitoring, evaluation, and cost-effectiveness: - Base ALMPs on evaluation mechanisms to assess short- and long-term impact relative to spending. - Improve targeting and cost-benefit considerations because international evidence shows ALMPs are not always very effective and design quality significantly influences success. *Annex I. Active Labor Market Policies in Spain (cr17319).* ### Appendix II. External Sector Assessment ### Appendix II. External Sector Assessment ### Technical background notes - Based on data available through 2016:Q4. - The EBA CA regression-based approach estimate would suggest a CA surplus of 1.8 percent of GDP. - The estimated EBA CA norm is roughly 1 percentage points of GDP higher than in 2015 largely as a result of revised demographic projections, which point to a faster aging speed than previously anticipated. - The empirically-based EBA norm does not fully account for the very negative NIIP, with around a quarter of liabilities in the form of equity. - Given external stability considerations, a CA norm in the range of 2–4 percent of GDP is necessary to strengthen the NIIP by about 5 percent of GDP annually over the next 5–10 years. ### External risks — likelihood, impact, and policy responses - Structural weak growth in key advanced economies - Relative Likelihood: High - Impact if Realized: Medium - Staff judgment on effects: Low productivity growth, failure to fully address crisis legacies and undertake structural reforms, and persistently low inflation undermine medium-term growth. Slowing external demand would weigh on growth and employment. A rise in NPLs could weaken banks’ balance sheets. Persistently low imported Euro Area inflation would worsen private and public debt dynamics; low Euro Area inflation would make Spain’s adjustment more difficult. - Policy response: - Enhance labor market performance and lower duality. - Deepen product market reforms and other structural reforms to raise productivity. - Let automatic stabilizers play in case the output gap widens. - Continue strengthening the financial sector and its capacity to support growth. - Retreat from cross-border integration - Relative Likelihood: Medium - Impact if Realized: Medium - Staff judgment on effects: Could lead to protectionism and economic isolationism, reducing policy collaboration and negatively affecting cross-border flows and growth. Increased uncertainty regarding the future of Europe may affect confidence and investment. However, ECB policies mitigate against excessive financial volatility. - Policy response: - Accelerate structural reforms to strengthen competitiveness, in particular enhance labor market performance and lower duality. - Let automatic stabilizers play in case the output gap widens. - European bank distress - Relative Likelihood: Medium - Impact if Realized: Medium - Staff judgment on effects: Strained balance sheets and weak profitability lead to financial distress in one or more major banks, with broader effects on the financial sector. Tightening of financial conditions; bank-sovereign-real economy links could re-emerge via loss of market confidence. However, the ECB’s policies mitigate against excessive financial volatility. - Policy response: - Accelerate structural reforms and formulate credible medium-term fiscal path to support investor confidence. - Banks to continue building capital buffers. - Further ECB policy actions could help depending on the nature of the shock. - Policy uncertainty - Relative Likelihood: High - Impact if Realized: Medium - Staff judgment on effects: Uncertainty from two-sided risks to US growth, negotiation of post-Brexit arrangements, and evolving political processes (including elections). Weaker external demand from the U.K. and the euro area if knock-on effects are stronger than in the baseline. Trade and banking linkages are strong. - Policy response: - Accelerate structural reforms and formulate credible medium-term fiscal path to support investor confidence. - Let automatic stabilizers play in case the output gap widens. - Significant slowdown in emerging economies - Relative Likelihood: Medium - Impact if Realized: Low - Staff judgment on effects: Turning of credit cycle and lower potential growth generates disorderly household and corporate deleveraging in emerging economies. Weaker growth, especially in Latin America, could reduce the profitability of Spain’s global banks (and large corporates) which would weaken contributions to the parents’ capital buffers. Trade linkages are limited. - Policy response: - Continue strengthening the financial sector and its capacity to support growth. - Close coordination with supervisors in host countries. ### Domestic risks (Risk Assessment Matrix highlights) - Weak implementation of fiscal commitments and structural reforms or reversal of past policy achievements - Relative Likelihood: Medium - Impact if Realized: High - Staff judgment on effects: Traction for structural reforms is low in a fragmented parliament with a minority government. A credible medium-term fiscal path has yet to emerge. Lack of or reversal of reforms and fiscal consolidation could weaken confidence, investment, and employment, which would adversely impact public debt dynamics and could trigger adverse market reactions. - Policy response: - Advance ongoing structural reforms and enhance labor market performance. - Return to gradual, steady and growth-friendly fiscal consolidation. - Reform the regional financing framework to reduce fiscal risks. - Higher than estimated growth momentum created by past reforms - Relative Likelihood: High - Impact if Realized: Medium - Staff judgment on effects: Past labor market reforms reduce structural unemployment rate more than currently estimated, increasing the economy’s potential to growth. Robust job creation could continue in the medium term without creating wage pressures. This would also sustain strong private consumption growth in the medium term. - Policy response: - Use any windfall revenues to reduce the high public debt. - Continue structural reform efforts, given still considerable structural weaknesses. - Note on the RAM: The relative likelihood assessments are staff’s subjective probabilities (“low” <10 percent, “medium” 10–30 percent, “high” ≥30 percent). Non-mutually exclusive risks may interact and materialize jointly. ### Appendix IV. Debt Sustainability Analysis — Public debt key findings and baseline - Public debt sustainability risks remain sizeable, despite the reduction of the headline fiscal deficit over the last seven years. - Under the baseline scenario: - Public debt is projected to decline slowly over the medium term from the peak of 100.4 percent of GDP in 2014. - Public debt is projected at 92.2 percent of GDP in 2022. - Gross financing needs have declined below the 20 percent of GDP early warning benchmark and are projected to continue to fall gradually over the medium term. - At 19 percent of GDP in 2017 gross financing needs are the highest in the euro area. - Policy priority: Returning to a gradual but steady and credible fiscal consolidation remains a priority. - An annual structural adjustment of about ½ percent of GDP over the medium term would put debt firmly on a downward path, bringing it to around 88 percent of GDP by 2022—4–5 percentage points lower than under the baseline. ### Public Debt Sustainability Analysis — background, developments, and assumptions - Definitions and coverage: - Public debt comprises Excessive Deficit Procedure (EDP) debt in the hands of the General Government. - The General Government includes the Central Government, Regional Governments, Local Governments, and Social Security Funds. It includes only those public enterprises that are defined as part of General Government under European System of Accounts. - EDP debt is a subset of General Government consolidated debt and the stocks are recorded at their nominal value. - Developments: - Public debt-to-GDP increased from 35.5 percent of GDP in 2007 to 99.4 percent of GDP in 2016, driven by large fiscal deficits (of about 7½ percent of GDP on average during 2008–16), and a largely unfavorable growth interest rate differential until 2015 (which contributed an annual average of about 2½ percent of GDP). - The support to the banking sector added about 4½–5 percent of GDP to the public debt stock. - Gross financing needs have declined below 20 percent of GDP after peaking at 22 percent in 2012, on the back of an ongoing maturity extension and nominal deficit reduction. - The ECB’s quantitative easing has helped bringing sovereign bond yields down. The 10-year bond yield has declined from about 6¾ percent in mid-2012 to about 1 1/2 percent in July 2017. - The effective interest rate on outstanding debt has also declined, and interest payments are expected to remain below 3 percent of GDP in 2017. - Other factors: - The amortization profile of public debt is tilted towards the long term (92 percent of total debt, on a residual maturity basis). - The marginal life at issuance has increased steadily since 2012, from 5 years to over 11 years in 2016, with the average life of outstanding debt increasing from 6.2 to 7 years over the same period. - Holdings of public debt are relatively well diversified. The share of marketable debt held by the Spanish banking system has continued to fall to about 20 percent, while that of the ECB has increased to 18 percent. - The share of public debt held by residents declined by 12 percentage points since 2012 to 55 by end-2016. - The stock of financial assets has gradually declined since 2014 to about 33 percent of GDP in 2016. Nonetheless, the assets are a risk mitigating factor, with net public debt levels amounting to 80 percent of GDP. - Baseline projections and assumptions: - Public debt is projected to fall marginally to 98.6 percent of GDP in 2017, and continue declining slowly to 92.2 percent by 2022. - Gross financing needs are expected to remain below 20 percent, and gradually decline over the projection period; at 15.8 percent of GDP in 2022 they would remain relatively high compared to other euro area countries. - Key macro-fiscal assumptions: - Growth is projected to be 3.1 percent in 2017 and moderate to 2.4 percent in 2018, as the effect of tailwinds dissipates. - Over the medium term, growth is set to converge toward its potential rate of around 1¾ percent. - A structural adjustment of around ½ percent of GDP in 2017, followed by a broadly neutral fiscal stance over the medium term in structural primary terms. - Inflation (based on the GDP deflator) is projected to increase gradually from 0.3 percent in 2016 to 1¾ percent in 2022. - Long-term sovereign spreads are assumed to increase slowly from [text truncated in source]. *Source: cr17319 - Appendix II. External Sector Assessment* ### 1.2 percent in 2017 to 1.8 percent in the medium term, with 10-year bond yields increasi ### cr17319 - 1.2 percent in 2017 to 1.8 percent in the medium term, with 10-year bond yields increasi ### Stress tests — Public debt dynamics and scenarios - Under baseline, public debt dynamics are broadly flat or increase under standard shocks; debt dynamics worsen significantly if contingent liabilities materialize or if negative shocks to GDP growth and the primary balance occur simultaneously. - Growth shock (2018–19): real GDP growth is lower than baseline by one (10-year historical) standard deviation for two consecutive years. - Implied average real GDP decline: 0.5 percent per year versus baseline annual average growth of 2.2 percent. - Primary balance weaker by about 2 percent of GDP per year, on average. - Debt-to-GDP ratio: reaches 106 percent of GDP in 2019, declining to 101.8 percent in 2022 (about 9 percentage points higher than baseline). - Gross financing needs: reach 20.6 percent in 2019 (slightly above the 20 percent benchmark). - Primary balance shock (2018–19): cumulative deterioration of the primary balance of 2 percent of GDP (shock equal to ½ the 10-year historical standard deviation of the primary balance-to-GDP ratio). - Debt-to-GDP ratio: peaks at 99.2 percent of GDP in 2019, declining to 93.8 percent of GDP in 2022 (1.2 percentage points higher than baseline). - Gross financing requirements: higher than baseline. - Interest rate shock (2018–22): nominal interest rate shock of about 240 basis points. - Effective interest rate: increases to 4.0 percent by 2022 compared to 2.8 percent in baseline. - Debt-to-GDP ratio: remains broadly stable at 94.6 percent in 2022. - Fiscal space: sizeable and sustained increase in interest rates would reduce fiscal space. - Combined shock (simultaneous growth, primary balance, and interest rate shocks): - Debt-to-GDP ratio: increases to 107.1 percent in 2019, remaining near this level through 2022 (almost 13 percentage points higher than baseline). - Gross financing needs: peak at over 21.3 percent of GDP in 2019. - Contingent liability shock (negative financial sector shock, one-time increase in non-interest public expenditures in 2018 equivalent to 10 percent of banking sector assets, combined with lower growth and lower inflation in 2018–19; growth reduced by 1 standard deviation): - Primary deficit: rises to 10 percent of GDP in 2018. - Gross financing needs: reach 27.7 percent of GDP (about 8 percentage points above standard early warning benchmark levels). - Debt-to-GDP ratio: peaks at 113 percent in 2019, declining to about 109.3 percent in 2022 (about 15 percentage points higher than baseline). ### Heat map and public debt risk assessment - Benchmark breached: risks associated with public debt remain high as the benchmark level (85 percent of GDP) is breached under the baseline and in each shock scenario. - Gross financing needs: remain below 20 percent of GDP under the baseline but surpass that benchmark in the output shock, primary balance shock, and contingent liability scenarios. - Debt profile risks: stem from the high level of external financing needs and, to a lesser extent, from the share of public debt held by non-residents. ### External Debt Sustainability Analysis (External DSA) - Baseline projection: - External debt: projected to decline from peak of 169.1 percent of GDP in 2015 to about 144 percent of GDP in 2022. - Assumes gradual convergence of real GDP growth to estimated potential growth of around 1¾ percent. - External current account balance: remains around 2 percent of GDP. - External debt-to-exports ratio: projected to sharply decline by around 100 percentage points during 2017–22. - Gross external financing needs: continue to decrease but remain high, around 62 percent of GDP in 2022. - Alternative external DSA scenarios indicate external debt remains high and gradual decline depends on avoiding large adverse macro shocks. ### External stress-test scenarios and impacts - Historical shock scenario (2007–2016 properties): assume real GDP growth path of 0.4 percent since 2018 and nominal external interest rate higher by 0.3 percentage points than baseline. - External debt: increase to 197 percent of GDP by 2022. - Interest rate shock (one-half standard deviation increase): from 2.5 percent baseline to 2.9 percent. - External debt: higher by 3 percentage points than baseline at end-2022. - Growth shock (real GDP growth averaging 0.6 percent between 2018 and 2022 versus 2 percent baseline): - External debt: reaches 154 percent of GDP in 2022. - Non-interest current account shock (current account surplus excluding interest payments averages 3.7 percent of GDP rather than 5.7 percent baseline): - External debt: 153 percent of GDP in 2022. - Combined shock (¼ standard deviation shocks to real GDP growth, external interest rate, and current account balance): - External debt-to-GDP ratio: 155 percent in 2022. - Real depreciation shock (one-time 30 percent real depreciation): - External debt ratio: increases by 1 percentage point of GDP in 2022 (valuation channel; low share of foreign-currency debt limits transmission). ### Key baseline projections and indicators (selected figures as of July 14, 2017) - Nominal gross public debt (percent of GDP): 2015: 64.2; 2016: 99.8; 2017: 99.4; 2018: 98.5; 2019: 97.1; 2020: 95.6; 2021: 94.3; 2022: 93.2; later: 92.2. - Public gross financing needs (percent of GDP): 2015: 15.1; 2016: 20.0; 2017: 19.4; 2018: 19.1; 2019: 16.9; 2020: 16.4; 2021: 16.1; 2022: 15.9; 2023: 15.8. - Real GDP growth (percent): 2015: 0.1; 2016: 3.2; 2017: 3.2; 2018: 3.1; 2019: 2.5; 2020: 2.0; 2021: 1.9; 2022: 1.7. - Inflation (GDP deflator, percent): 2015: 1.1; 2016: 0.5; 2017: 0.3; 2018: 1.2; 2019: 1.5; 2020: 1.7; 2021: 1.6; 2022: 1.7. - Effective interest rate (percent): 2015: 4.1; 2016: 3.2; 2017: 2.9; 2018: 2.9; 2019: 2.8; 2020: 2.7; 2021: 2.7; 2022: 2.7. - Change in gross public sector debt (cumulative, percent of GDP): 2015: 6.5; 2016: -0.6; 2017: -0.5; 2018: -0.9; 2019: -1.4; 2020: -1.5; 2021: -1.3; 2022: -1.1; cumulative through 2022: -7.2. - Identified debt-creating flows (cumulative): 2015: 6.1; 2016: 1.9; 2017: 1.4; 2018: -0.6; 2019: -1.2; 2020: -1.3; 2021: -1.2; 2022: -1.2; cumulative through 2022: -6.6. - Primary deficit (percent of GDP): 2015: 4.1; 2016: 2.4; 2017: 2.0; 2018: 0.6; 2019: 0.0; 2020: -0.3; 2021: -0.5; 2022: -0.5; cumulative through 2022: -1.1. - Primary (noninterest) revenue (percent of GDP) cumulative through 2022: 226.6. - Primary (noninterest) expenditure (percent of GDP) cumulative through 2022: 225.5. ### Composition of public debt and alternative scenarios (selected comparisons) - Baseline real GDP growth (percent): 2017: 3.1; 2018: 2.5; 2019: 2.0; 2020: 1.9; 2021: 1.7; 2022: 1.7. - Historical scenario real GDP growth (percent): 2017: 3.1; 2018–2022: 0.4 each year. - Baseline primary balance (percent of GDP): 2017: -0.6; 2018: 0.0; 2019: 0.3; 2020: 0.5; 2021: 0.5; 2022: 0.5. - Historical scenario primary balance (percent of GDP): 2017: -0.6; 2018–2022: -4.5 each year. - Constant primary balance scenario primary balance (percent of GDP): -0.6 each year. ### Additional DSA diagnostics and monitoring metrics - External debt (percent of GDP): baseline path 2012–2022 shows decline from recent peaks to 144 percent by 2022; historical and shock scenarios can raise external debt substantially (historical to 197 percent by 2022). - External debt-to-exports ratio and gross external financing needs remain elevated, despite projected declines. - Forecast track record (2007–2015): Spain median forecast errors: - Real GDP growth forecast error: -0.48 (Spain median forecast error, percentile rank: 51%). - Primary balance forecast error: -0.95 (percent of GDP; percentile rank: 39%). - Inflation (deflator) forecast error: -0.54 (percent; percentile rank: 28%). - Booms-busts and realism of projected fiscal adjustment: Spain has percentile ranks reported for 3-year CAPB adjustments and levels (3-year adjustment percentile rank 57%; 3-year average CAPB level percentile rank 70%). *Italic: Source: IMF staff (Spain Article IV Consultation and DSA content as provided).* ### 0.1 percentage point higher than in July and June, while core inflation decelerated to ### cr17319 - 0.1 percentage point higher than in July and June, while core inflation decelerated to ### Inflation and prices - Headline inflation was 0.1 percentage point higher than in July and June. - Core inflation decelerated to 1.2 percent—0.2 percentage point lower than the July reading. - The divergence between headline and core inflation is driven by increased fuel prices, which more than offset deceleration pressures coming from services inflation. ### Employment and labor market - Employment grew by 2.8 percent y-o-y in the second quarter of 2017, bringing the number of unemployed down to 3.9 million, the lowest level since 2009:Q1. - Employment creation is currently growing around 3 percent. - The number of unemployed has fallen below 4 million for the first time since 2008. - IMF projections for 2018 are broadly in line with authorities’ estimates, with the unemployment rate expected to hover around 15 percent, well below the 27 percent peak reached during the crisis. - Spain has already recovered close to half of the employment lost. - Youth unemployment continues to fall at historical maximum rates of 16 percent. - Long-term unemployment is falling at rates of over 20 percent. - The authorities welcome the emphasis on active labor market policies and Fund policy advice. - The Government has adopted specific measures to reduce duality in the labor market and to make permanent contracts more attractive; authorities disagree with the IMF recommendation to introduce a single open contract. ### National accounts and growth composition - Detailed national accounts data for the second quarter confirmed the flash estimate of real GDP growth of 0.9 percent q-o-q. - The composition of first quarter GDP growth was revised: somewhat higher public consumption and one percentage point lower import and export growth rates. - Spain’s National Statistics Institute revised historical national accounts data for 2014–16, resulting in: - Upward revision of real GDP growth in 2015 to 3.4 percent and in 2016 to 3.3 percent compared with the previous estimate of 3.2 percent for each year. - Revisions to GDP deflators. - In 2016, the level of GDP at current prices is now 0.4 percent higher compared with the previous estimate. - For 2016 composition: final consumption growth revised to 2.5 percent (vs. 2.6 percent previously); gross capital formation growth revised to 3.1 percent (vs. 3.8 percent previously); external demand contribution revised to 0.7 percentage point (vs 0.5 percentage point previously). ### External sector - The Spanish economy is expected to record surpluses in the current account balance of around 2 percent of GDP in the coming years. - 2017 will mark the fifth consecutive year of current account surplus, and the sixth year as a net lender to the world. - The NIIP and the ratio of external debt to GDP are expected to continue their downward trend. - Export growth is estimated to grow at 6 percent in 2017 and has been a main driver of the correction. - Export performance is attributed to competitiveness gains from contained unit labor costs and corporates’ increasing capacity to implement internationalization plans. ### Fiscal policy - Authorities concur with staff’s recommendations to continue fiscal consolidation and are firmly committed to reduce public deficit and debt. - During the first half of 2017, public deficit (excluding local Government) has been reduced by more than 22 percent. - There is broad consensus that the target of 3.1 percent of GDP for 2017 will be achieved. - Authorities do not share staff’s proposal to increase the VAT base and other environmental taxes, citing a significant shift already towards indirect taxes and concerns about competitiveness and equity consequences. - Authorities appreciate staff’s SIP analysis on the future of the pension system and concur on the need to ensure financial sustainability while considering social acceptability; they emphasize uncertainty in population projections and long-run macroeconomic assumptions. ### Private sector deleveraging - Private sector deleveraging has continued throughout 2017. - Spain’s private deleveraging of both corporate and household sectors is more than 50 percentage points of GDP since the peak, placing leverage ratios broadly in line with European peers. - Deleveraging is concentrated in the real estate and construction sectors and has been compatible with increased new credit flows to SMEs in industry and export-oriented sectors. - Deep financial reforms since 2012 have fostered deleveraging and improved the banking system’s capacity to finance recovery. ### Financial sector resilience and reforms - The 2017 FSAP was carried out in a very different context from 2012; bold reforms since 2012 have increased resilience and solvency of the financial system. - Spanish banks have strengthened capital ratios despite structurally higher asset densities; the total capital ratio increased to 14.8 percent by end-2016. - The system is positioned to withstand severe shocks as evidenced by stress testing under very extreme adverse scenarios. - NPLs declined by 40 percent over three years, standing at 5.5 percent (1Q2017), very close to the EU average. - Provisioning efforts and 2012 regulatory changes increased loss absorption capacity by more than 80 billion and helped build buffers. - SAREB has been instrumental in cleaning up bank balance-sheets and limiting fallout from the banking crisis; authorities note an existing monitoring commission and caution about potential conflicts from including FROB in oversight. - Liquidity analysis in the FSSA shows all banks would have enough liquid assets to cover outflows for longer than a year. - Authorities do not share concerns about excessive reliance on ECB funding, expecting a gradual reduction in excess liquidity without disorderly unwinding. - Low interest rate environment places pressure on net interest margins, but steepening of the yield curve may benefit banks given prevalence of variable rates. - IRRBB stress test by the SSM confirms Spanish banks are well positioned for an increase in rates. - Based on the latest EBA Stress Test exercise, sovereign exposure of Spanish banks is 13 percent for Spain and 11.5 percent on average for European banks. - Bank resolution framework has strengthened following transposition of the BRRD into Spanish law, helping break the bank-sovereign nexus and preserve taxpayers’ money; the resolution of Banco Popular under the Single Resolution Board saved all deposits with no public funds involved. - Authorities see FSSA and FSAP recommendations on profitability, liquidity management, and macroprudential arrangements as useful; they see merit in establishing a Systemic Risk Council. - Ongoing and planned institutional reforms include integrating accounting competences in CNMV; setting up an independent supervisory agency for insurers and pension funds; setting up a new Ombudsman to protect consumers; a new Mortgage Credit Law to increase transparency; transposition of MiFID II to improve investor protection and foster SME access to funding; and a new regulation to strengthen transparency of senior staff appointments and accountability in financial authorities. *Statement by Jorge Dajani, Estefanía Sanchez Rodriguez, and Fernando Lopez, September 20, 2017.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17319.pdf_